End-of-year tax considerations
As the year draws to a close, now is a good time to gather your financial documents and review the impact of any real estate (or other financial) transactions. If you bought or sold property, there are undoubtedly tax implications.
The best place to start is to review your transaction’s closing document. If you cannot put your hands on it, your Realtor can help you acquire a copy. If you purchased property, the goal is to maximize tax deductions. If you sold property, you may need to pay taxes on your earnings. If you bought or sold property via a 1031 exchange, you may be able to defer at least a portion of your tax liability. For more on that, read my blog on the subject at https://selzerrealty.com/2013/12/23/1031exchanges.
Purchases
If you bought property, you’ll want to determine the capitalized cost or tax basis of your property, which is especially important if the property is income-generating. The capitalized cost includes not only the purchase price, but all the other non-recurring expenses associated with buying property—things like inspection fees, escrow fees, and title insurance. The reason this is important for income property is because the higher the value, the more depreciation and amortization you can write off. The land your house sits on is not depreciable, but pretty much everything else is. In the real estate business, we refer to everything except raw land as “improvements,” including structures, landscaping, pools, fencing, and any other amendments to the land. The non-recurring expenses are amortized.
Even if you do not use the property for income purposes, it is important to have an accurate basis, so when you eventually sell the place (or your heirs do), there’s an accurate record from which to calculate capital gains.
Sales
If you sold property, you may owe taxes
Let’s use an example, so you can see how this works. Say you bought a 3,500-square-foot home in Rogina Heights 47 years ago for $67,500 and now you want to sell it. You’ve added $25,000 worth of improvements over the years, and because you are a rare individual, you’ve kept all the receipts and cancelled checks to prove it. You’ve lived in the house the whole time, so there’s been no depreciation (that’s only for income properties), making your current adjusted tax basis $92,500. The stars align and you instantly find a buyer. The net of all fees and expenses on the sale is $800,000, for a profit of $707,500.
If you’re married, there’s a $500,000 capital gains exemption on owner-occupied properties. If you are single, there’s a $250,000 capital gains exemption on owner-occupied properties. Let’s say you’re married. If you subtract your $500,000 exemption and your $92,500 basis from your $707,500 earnings, you’ll be responsible for paying capital gains taxes on the remaining $115,000. So, even with a sizable exemption, you’ll still have to pay state and federal taxes. The precise amount depends on your personal financial situation.
All of this presumes there was no 1031 exchange in the purchase or sale of your property this year or in the original acquisition of the properties. As always when I venture into the world of taxes and finance, my intent as I write these columns is to make you aware of real estate information to help you pose questions. For answers, you should consult your tax accountant and/or financial advisor.
The takeaway here is that if you completed a real estate transaction this year, now is a good time to collect your documents and, if needed, reconstruct the details so you have accurate records. It’s a pain, but worth the effort.
If you have questions about property management or real estate, please contact me at rselzer@selzerrealty.com or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery. To see previous articles, visit www.selzerrealty.com and click on “How’s the Market.”