A home is one of the biggest purchases you will make in your lifetime. However, while the costs of owning and maintaining a home are pretty clear, taxes are a little less clear-cut. As a homeowner, you may have questions about what happens when you sell your home or where you’ll pay taxes if you own two houses.
In this post, we’ll be answering three of the top real estate tax questions.
1. If I Sell My Home, How Will the Funds Be Taxed? What Can I Do with the Money?
Did you know that your home is considered a capital asset? Traditionally, capital assets are subject to capital gains tax. So, if your home appreciated in value, you would be required to pay taxes on the profit.
- Tax rates for long-term capital gains are 0%, 15%, or 20%, depending on your income and your filing status. Long-term gains apply to real estate owned for at least two years.
- Short-term gains will apply if you owned the home for less than two years. They will be taxed as ordinary income. Tax rates can be as high as 37%.
Fortunately, most homeowners are able to avoid capital gains tax thanks to the Taxpayer Relief Act of 1997. The Act introduced IRC (Internal Revenue Code) Section 121, which allows homeowners to exclude a portion of their capital gains when selling their primary residence if they meet certain requirements.
Section 121 allows you to exclude:
- Up to $250,000 of the gain if you’re single
- Up to $500,000 of the gain if you’re married and filing jointly
In order to take advantage of Section 121, you must have lived in the home for at least two years (they do not have to be consecutive years).
Also, Section 121 can only be used once every two years.
Of course, not everyone will be able to take advantage of Section 121. In certain situations, gains from a home sale may be fully taxable. You may have to pay capital gains tax if:
- You are subject to expatriate taxes
- The property was not your primary residence
- The home was purchased through a 1031 exchange within the last five years
- You sold a home within the previous two years and used a capital gains exclusion
If you are ineligible for a capital gains exclusion, talk to an accounting professional. There may be other ways to reduce or avoid capital gains tax on the sale of your home.
What about the sale proceeds? What can I do with the funds?
Many homeowners use the proceeds from their home sale to purchase another home. However, you can use these funds any way you please. You’re free to invest it, spend it or save it – the choice is yours.
2. If I Move Part Way Through the Year, Which State Do I Pay Taxes In?
Rarely do moves happen exactly at the start of a new year. Whether you’re moving in October or March, you may be wondering how your taxes will be handled.
Your federal taxes may not be affected, but if you move to a new state, you will likely need to file a tax return in each state you lived in during the year. The only exception here is if you’re moving to/from a state with no income taxes, such as:
- South Dakota
New Hampshire and Tennessee don’t have state income taxes, but they do tax dividends and interest income.
Otherwise, if either state has state income taxes, you will likely have to pay taxes in both states for the time you resided there. Thanks to a 2015 Supreme Court ruling, you don’t have to worry about double taxation. You will only be required to pay taxes on the portion of income earned while living in each state.
If you lived in multiple states throughout the year, your taxes can quickly become complicated. Consider working with a tax professional who can help determine how much taxes should be paid in each state and walk you through the filing process.
3. If I Own a Second Home, Which State Do I Pay Taxes In?
If you purchase a second home in another state, you may be wondering where you pay taxes.
- Property taxes will be paid to each property’s respective state. So, if your primary residence is in California and your second home is in Texas, you will pay property taxes on your California home to the state of California and the property tax on your Texas home would be paid to the state of Texas.
If you’re the only one using the second home (meaning that you’re not renting it out), you may be able to write off the mortgage interest and property taxes on your federal taxes. You can rent out the property for less than 14 days each year and still deduct these expenses.
It’s important to note that there is a limit on how much property tax you can deduct. The total amount of property tax that you can deduct each year is $10,000. Depending on your location, you can quickly go over that limit with just a single property.
For example, the property tax rate in New Jersey is 2.44%, and it’s not uncommon for residents to pay more than $10,000 per year in taxes.
If you rent out the property for more than 14 days each year, it could be considered a rental property. In this case, you can write off the property taxes, mortgage interest, and expenses associated with the rental, such as maintenance, utilities, and repairs.
Keep in mind that if you sell the property, the proceeds could be subject to capital gains tax.
Real estate taxes can be complicated, especially if you own multiple properties and rent them out. Consulting with a tax professional can help you better understand your tax situation and ensure that you’re taking advantage of every opportunity to reduce your tax burden.
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