By Felipe Mejia, CFP®

If you sold your home after the pandemic began, you may have brought in a sizable profit. According to Redfin, home prices in Florida are up 20.4% compared to last year, with the median days on the market being 23 days. In addition, 39.1% of homes in Florida sold above list price.[1]

Sometimes such profit can throw taxpayers for a loop when it comes time to give Uncle Sam his piece of the pie. 

“Capital gains” is the term used when you sell an asset for more than you paid. In the financial world, we typically discuss this in relation to stocks, bonds, and mutual funds. For example, if you buy a share of stock for $100 and later sell it for $150, you have a capital gain of $50.

The capital gains tax can be either long term (asset held for one year or more) or short term (asset held less than one year). Long-term capital gains are usually more favorable to the taxpayer and typically do not exceed 15% for most individuals.[2]

Short-term gains are taxed the same as ordinary income, which is usually people’s highest individual income rate.

So how does this all work in real estate? For the most part, the same as other assets. If you own a home for less than one full year and sell for a profit, get ready to pay the higher short-term capital gains rate. Hold and sell after the one-year mark, and you pay the long-term capital gains rate. The exact amount depends on your tax bracket, marital status, and other factors.

Like stocks, the price you paid for real estate is considered your basis, but you can also add in closing costs, agent fees, capital improvements, and repairs. Instead of being reported on your 1099, the sale of real estate will be on Form 8949 and Schedule D. It is best to work with a tax advisor to complete and review your tax return due to the complexity of reporting.

Can you alleviate some of this tax bill? Yes! One of the easiest ways is taking advantage of the primary residence exclusion, also known as Section 121. To qualify, you must pass the “ownership” and “use” tests. According to IRS.gov, you are generally eligible for the exclusion if “you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale.”

What this means is that a home seller can move into an investment or rental property for two years before the sale so that they can take advantage of the exclusion. For individuals, the exclusion can include up to $250,000 in capital gains, and married couples may exclude up to $500,000.[3]

Another way to reduce gains on an investment property sale is by looking into a 1031 exchange.  When selling an investment property, you may effectively trade one property for another. This means you can profit and flip your investment into a like-kind exchange while deferring taxation until you sell the new investment many years later.

If done properly, there is no limit on the number of 1031 exchanges you do. While you may have a profit on each exchange, you might only have to pay the tax one time at a more favorable long-term capital gains rate in your lower-income years. Working with a professional advisor can help you in taking the appropriate steps for a proper exchange.[4]

Finally, your capital gains bill may also be reduced by using the losses from the sale of other assets to offset the gains of your real estate sale. Just like in our hypothetical stock sale, if you buy a stock for $100 and later sell it at a loss for $50, you now have a capital loss of $50. You can use that loss to subtract from the gain on your real estate transaction. While the goal of stock investing isn’t to sell at a loss, well-timed trades to “harvest” losses can help you lower taxable gains either in the same year or even future years.[5]

With the right professional network team—your tax professional, financial advisor, real estate agent, and even an attorney—all on the same page, you can enhance your wealth and optimize your tax mitigation strategies. Proper planning should take place before, during, and after the transaction is complete to ensure that you are not paying any more in taxes than you have to.

You can explore the topic further with your legal or financial professional to help you consider the right next step. Our Plantation, FL wealth management firm is always here to help answer our clients’ questions about estate administration.

Schedule a complimentary consultation with one of our fee-only financial planners to discuss your personal situation.

Notes:

1. https://www.redfin.com/state/Florida/housing-market

2. https://www.irs.gov/taxtopics/tc409

3. https://www.irs.gov/taxtopics/tc701

4. https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx

5. https://www.investopedia.com/articles/taxes/08/tax-loss-harvesting.asp