Know the rules and avoid a tax surprise!
Are you thinking about making a major purchase?
Whether that purchase is your primary house, a rental property, shares of stock or a piece of art, begin with the end in mind by thinking through how the property you’re buying is treated for tax purposes when you sell it. That’s because there are many different tax rules for different types of properties generally referred to as assets.
How assets are taxed: The general rule
If you sell your property for more than what you bought it for, you’ll get a tax bill. How much your tax bill will be depends on the following factors:
- How long you own the property. If you sell your asset(s) LESS than one year after purchasing it, your tax will be calculated based on short term capital gain tax rates. If you sell your asset(s) MORE than one year after purchasing it, your tax will be calculated based on long term capital gain tax rates.
- Your adjusted gross income. Short term and long term capital gain tax rates are based on your income. In 2021, short term tax rates can range from 0% to 37% while long term tax rates can range from 0% to 20%. If your income is high enough, there is also a 3.8% surtax on investment income on top of the short term or long term tax rate.
Different assets, different rules
The taxes applied when you sell an asset also fluctuate depending on the type of property it is:
Securities. Common securities include stocks, bonds, and mutual funds. While taxes on securities generally follow the above rules, there are a few wrinkles. First, you can only take $3,000 in excess losses in one year to reduce your earned income. On the other hand, you can net losses with gains from the sales of other stocks. If you sell a stock for a loss with the hope of a tax savings but buy similar stock within 30 days of the transaction, your ability to report the loss can be restricted!
Primary home. While your primary home technically follows the general rule of how assets are taxed as outlined above, most taxpayers never get a tax bill. When you sell your primary home, you can exclude the first $250,000 of taxable gain if you’re single or $500,000 if you’re married. You must own and live in your primary home for 2 of the previous 5 years to qualify for this tax break.
Rental properties. When selling a rental property, you could be hit with both short term tax rates and long term tax rates. You’ll also discover a tax term called depreciation recapture, which could significantly increase the amount of tax you owe on your property.
Collectibles. The IRS generally treats collectibles such as artwork or antiques as capital assets. But there are special capital gains rules when you sell collectibles. Instead of using the long term capital gains tax rates outlined above, gains on the sale of collectable items is subject to a 28% tax rate.
Ideas to minimize your tax bill
Given the complexity of applying tax law to the sale of assets, here are some suggestions:
- Get professional advice before buying an asset.
- Get professional advice before selling an asset.
- Keep good records. Accurate records of what you paid for a piece of property or an asset is key to proving whether taxes are due when you sell it and what tax rate applies. So keep all records related to the purchase, improvement and sales price of any property or asset, and ensure proper dates are on all documents.
The good news is you do not need to remember all these rules. You just need to know when to ask for help.