Hi,
Yes, I know I should ask a professional tax advisor, but GA
researchers are often just as knowledgeable and a lot more fun. :-)
Here are condo specifics:
Purchased in 1996 for 75K (in California). Currently no mortgage. I
never lived in it; purchased as investment only - been renting it out
and declaring rental income on Schedule E (which I believe is taxed as
ordinary income). Let's say I sell today for 425K. Is the profit taxed
as ordinary income? Or taxed at capital gains tax rate (which I
believe is currently not too painful at 15%)?
I am not looking to avoid or defer tax - no Starker/1031 exchange in
this scenario. I will have to fork over lotsa dough to the IRS - just
wondering what the tax rate will be. I think it's "capital gains" tax
rate because this is (and always was) an investment. Thoughts?
Bonus question for $4 tip (and I never welsh). Out of curiosity, if I
sell my personal residence - and I qualify for the 250K tax exclusion
on the profit BUT the profit exceeds 250K (let's say it's 350K) - how
am I taxed on the extra 100K? Ordinary income? Or 15% capital gains
tax rate? This is my own home - it was never meant as a business
investment. Thanks very much!
-ga-ga...
Cute name... ; )
Whether the real estate is your own home or a rental unit, it
is still an investment, or, in tax terms, a capital asset,
regardless of whether it is a business investment. If held for
a period of more than one year, it becomes eligible for taxation
as a capital gain, under the lower tax rates which apply.
By way of contrast, if you hold a capital asset, such as a stock
or a piece of real estate, for 11 months and 15 days, it would
be taxed at the rate of your regular income tax bracket, which
can be seen on this page from MoneyChimp.com, so you could end
up paying as high as 35% in taxes:
http://www.moneychimp.com/features/tax_brackets.htm
There's a very useful article on The Motley Fool financial site
by the site's tax advisor, Roy Lewis, titled, 'Making Home Sale
Capital Gains Disappear', which discusses the ins and outs of
the capital gains tax for real estate:
"The law says that the property must be used as a principal
residence for at least two years during the five-year period
ending on the date of the sale of the residence."
http://www.fool.com/taxes/2000/taxes000428.htm
That can mean any two continuous years in the five-year period
prior to the sale of the residence. Given those conditions, an
owner can deduct 250K (or 500K, if married filing jointly) from
the sale price of the property, and pay capital gains tax on the
difference.
Additionally, if the sale of the property can be shown to be as
a result of certain 'unforeseen circumstances', such as:
- death,
- divorce or legal separation,
- becoming eligible for unemployment compensation,
- a change in employment that leaves the taxpayer unable to pay
the mortgage or reasonable basic living expenses,
- multiple births resulting from the same pregnancy,
- damage to the residence resulting from a natural or man-made
disaster, or an act of war or terrorism, and
- condemnation, seizure or other involuntary conversion of the
property.
...then the owner can claim a partial exclusion as follows,
according to the IRS Home Sale Exclusion Rules:
"...the maximum exclusion amount of $250,000 ($500,000 for a
married couple filing jointly) is limited to the percentage
of the two years that the person fulfilled the requirements.
Thus, a qualifying seller who owns and occupies a home for
one year (half of two years) ? and who has not excluded gain
on another home in that time ? may exclude half the regular
maximum amount, or up to $125,000 of gain ($250,000 for most
joint returns). The proportion may be figured in days or months."
http://www.irs.gov/newsroom/article/0,,id=105042,00.html
So why am I focusing so much attention on the 2-year residence
issue when you're asking about a rental condo? Because, going
back to Roy Lewis' article, you might want to consider the
benefits of moving into the condo and living there for the two
year requirement in order to give yourself the 250K or 500K
exclusion when you finally sell it. Also, the 2 years need
not be continuous. This is illustrated in this section of
IRS Publication 523, 'Selling Your Home':
http://www.irs.gov/publications/p523/ar02.html#d0e3597
Short of that scenario, you are selling a rental property,
and are entitled to no capital gains exclusions, however
it is still taxed under capital gains. Publication 523
covers all you need to know to figure your gains:
http://www.irs.gov/publications/p523/ar02.html#d0e514
Basically, it comes down to how much you sold it for minus
how much you paid, but you can add to how much you paid the
cost of:
"Additions and other improvements that have a useful life of
more than 1 year".
You can also subtract from the sale price any selling expenses:
- Commissions,
- Advertising fees,
- Legal fees, and
- Loan charges paid by the seller, such as loan placement fees
or "points.'
Also note that you generally cannot exclude the part of the
gain equal to the depreciation you claimed or could have
claimed for renting the house.
See the Table of Contents for Pub 523 for more:
http://www.irs.gov/publications/p523/ar02.html
Also see Publication 527, 'Residential Rental Property':
http://www.irs.gov/publications/p527/index.html
Okay, so now, to capital gains, from Publication 544,
'Sales and Other Dispositions of Assets':
"If you hold a capital asset longer than 1 year, the gain or
loss from its disposition is long term. Report it in Part II
of Schedule D (Form 1040)."
http://www.irs.gov/publications/p544/ch04.html#d0e6480
"If the total of your capital gains is more than the total of
your capital losses, the difference is taxable. However, the
part that is not more than your net capital gain may be taxed
at a rate that is lower than the rate of tax on your ordinary
income."
http://www.irs.gov/publications/p544/ch04.html#d0e6643
"The tax rates that apply to a net capital gain are generally
lower than the tax rates that apply to other income. These
lower rates are called the maximum capital gains rates.
The term 'net capital gain' means the amount by which your
net long-term capital gain for the year is more than your
net short-term capital loss.
See the Schedule D (Form 1040) Instructions."
http://www.irs.gov/publications/p544/ch04.html#d0e6804
Rather than digging into the instructions for form 1040,
let's go back to our tax expert, Roy Lewis, for the rates:
"Under the prior law, long-term capital gains (gains on
those assets held for more than one year) were taxed at
a maximum rate of either 20% or 10%, depending on your
income. Additionally, there was also a provision in the
old law that allowed for a reduced long-term gain rate
of 18% or 8% if your gain was attributable to what was
called 'superlong-term gains.'
But that's all changed now. The 2003 Tax Act reduces the
old 20% rate to 15% and the old 10% rate to 5%."
[...]
"Also, under the old law, there were two other special
capital gains rates. One was a 25% rate imposed on
depreciation taken on the sale of real property. The
other was a 28% gain on the sale of collectibles (such
as guns and coins). The new 2003 Tax Act did not change
those rates on those specialty gains."
[...]
"Here's some good news: For those of you looking down the
horizon, the new 5% capital gains rate will be reduced to
0% (that's right -- nada, nothing, zilch!) in 2008.
But don't get too excited. All these new tax provisions
sunset after 2008. Unless these changes are made permanent
before then, the tax law will revert back to the way it
was before the passage of the 2003 Tax Act. We still have
a few years before the sunset provisions kick in, but
remember that those provisions are out there."
http://www.fool.com/taxes/2003/taxes030613.htm
So, best case scenario: Sell the home you're currently
living in and deduct 250K/500K from the capital gains.
Move into your condo for 2 years and then deduct another
250K/500K from the sale of that unit.
Just a thought... ; )
sublime1-ga
Additional information may be found from further exploration
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the Google searches outlined below.
Searches done, via Google:
capital gains tax
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