What are Capital Gains in Real Estate?
When you sell a capital asset, such as real estate, you may have to pay capital gains tax on the proceeds of the sale. The amount of tax you owe depends on how long you held the asset before selling it. These are concepts you need to know to pass your real estate exam.
In this article, we will discuss capital gains in real estate and how to calculate them.
We will also cover the short-term and long-term capital gains tax rates, and how to avoid paying taxes on your profits. Finally, we will explain 1031 exchanges and their role in avoiding capital gains taxes.
What are capital gains?
Capital gains are profits from the sale of a capital asset, such as stocks, bonds, or real estate. The capital gains tax is a tax on these profits.
You only have to pay capital gains taxes if you sell the asset for more than you paid for it. If you sell the asset for less than you paid, you may be able to claim a capital loss on your taxes.
The capital gains tax rate depends on how long you held the asset before selling it. If you held the asset for one year or less, it is considered a short-term capital gain and is taxed at your ordinary income tax rate.
If you held the asset for more than one year, it is considered a long-term capital gain and is taxed at a lower rate. The long-term capital gains tax rate is 0%, 15%, or 20% depending on your tax bracket.
How to calculate capital gains taxes
To calculate your capital gains tax, you will need to know the following information:
- The purchase price of the asset
- The sale price of the asset
- The costs of selling the asset (such as commissions or fees)
Once you have this information, you can calculate your capital gain (or loss) with the following formula:
Capital Gain = Sale Price of Asset - Purchase Price of Asset - Selling Costs
If you have a capital loss, you may be able to deduct it from your other income on your taxes.
When do you pay capital gains taxes?
You only have to pay capital gains taxes when you sell the asset. If you hold onto the asset until you die, your heirs will receive a "step-up in basis" and will not have to pay capital gains taxes on the sale.
The step-up in basis is the difference between the original purchase price of the asset and its value at the time of your death.
For example, let's say you bought a house for $100,000 and it is worth $200,000 when you die. Your heirs will have a capital gain of $100,000 when they sell the house. But because of the step-up in basis, they will only have to pay capital gains taxes on the $100,000 gain.
How to avoid capital gains taxes
There are a few ways to avoid capital gains taxes. The first way is to hold onto the asset for more than one year. As we mentioned before, long-term capital gains are taxed at a lower rate than short-term capital gains.
Another way to avoid capital gains taxes is to use a capital gains tax deduction. This deduction allows you to exclude some of your capital gains from taxes.
To qualify for the capital gains tax deduction, you must meet the following requirements:
- You must have owned the asset for at least one year
- You must have used the asset for personal or investment purposes
- You must have sold the asset for a profit
You can also avoid capital gains taxes by doing an exchange. This is a complicated transaction, but essentially you trade one asset for another without paying any capital gains taxes on the sale.
This is called a 1031 exchange.
To do a successful exchange, you must follow these rules:
- You must trade the asset for another "like-kind" asset. This means the new asset must be similar to the old one in both type and value.
- You must complete the exchange within 180 days of selling the original asset.
- You must use a qualified intermediary to hold the proceeds from the sale of the original asset.
If you want to see some examples of questions that will be on the actual real estate exam, check out our free real estate practice exam. We have been named as the best real estate exam practice for 7 years in a row!
If you need to get your required educational hours done, check out our partners for online real estate education that can be done at your own pace from home or where ever you have internet access.
What Is A Planned Unit Development (PUD) In Real Estate?What is a Planned Unit Development in Real Estate? If you’re studying for your real estate exam, you’ve probably heard the term “planned unit…
What Is A Net Listing In Real Estate?What is a Net Listing in Real Estate? When you’re getting ready to take your real estate exam, it’s important that you know all…
Unilateral and Bilateral Contracts in Real Estate ExplainedWhat is The Difference Between Unilateral and Bilateral Contracts in Real Estate? There are a few key concepts that real estate students need to…
What You Need To Know About Estates For Years In Real EstateWhat is an estate for years in real estate? An estate for years in real estate? This is a question that often confuses people…
What Are Emblements In Real Estate?What are emblements in real estate? One of the topics you will come across when studying for your real estate exam is emblements. As…
What Is An Attorney In Fact In Relation To Real Estate?What is an Attorney in Fact Real Estate? When it comes to real estate, there are a lot of legal terms and concepts that…
Share This Article