It is always a good time to consider strategies related to tax reduction; one area that can be especially important is in the area of capital gains tax.
First of all, one needs to understand the term “capital gain.” Generally, capital gain tax is paid on the difference between the “basis” in the property (usually the purchase price) and the selling price. Property can refer to real estate, stocks, artwork, and collectibles. For example, if the purchase price for a house was $100,000 (the basis) and it sold for $350,000 (the selling price), capital gains tax would be owed on $250,000. One method to reduce the final tax on real estate is to keep good records of capital improvements. If the real estate you sell is your personal residence, a single person can exclude up to $250,000 of gain and a married couple can exclude up to $500,000 in gain. To qualify, you must have owned and lived in the home for at least two out of the five years prior to the sale. For a nursing home resident, the two-year requirement is reduced to one year. However, if you give your home to another person for whom it is not their personal residence, the new owner takes on your basis. So if parents purchase a vacation home for $25,000 many years ago and the current fair market value is $500,000, there is a gain of $475,000 and no personal residence exclusion if gifted to a child or children. This would be a different result if the new owner moved in for two years before the sale.
The actual amount of the tax depends upon your income, the federal capital gains tax rate (currently 15 percent) and the additional state tax (approximately 3+ percent in Pennsylvania). However, there are three exceptions. If you owned the property for less than one year, there will be short term capital gains tax which is essentially the same rate as it is for income tax. The second exception is that if an individual’s income is less than $36,600 or $77,200 for a married couple (both in 2018), there is no federal tax on capital gains. However, the capital gain is included in the income calculation so it may put a taxpayer over the threshold. The third issue is that if income (in 2018) for a single person exceeds $425,800 and $479,000 for a married couple, the federal tax rate increases to 20 percent plus the state tax rate. Additionally, be cautious with capital gain tax income if you are on Medicare; this can increase your Medicare Part B premium due to the increase in income.
On the other hand, property inherited at death receives a “step up” in basis, or is adjusted to the value on the date of death. Consideration must be given to other assets in the estate, and the current federal estate tax exemption. One final item is the fact that you may have offsetting losses in the year that you have capital gains.
It is very helpful to understand the rules to avoid costly mistakes, such as transferring property to others for the wrong reasons. Be sure to consult your attorney and accountant regarding the best way to manage potential capital gains. In addition, the personnel at ElderLawAnswers have come up with an article titled “5 Things to Know to Reduce your Tax on Capital Gains.”
Please contact OWM with further questions related to capital gains taxes.
Written by: Kathleen M. Martin, Esquire, CELA