Capital gains tax is one of the most significant considerations for investors thinking about selling their assets. Depending on the investor’s tax bracket and how long they held the asset, the capital gains tax can significantly reduce the realized profit from the sale of their investment.
Previously, taxpayers could benefit from a capital gains exemption for seniors. Now, everyone must pay capital gains tax on the sale of capital assets. If you are nearing retirement age or considering how your investment strategy could change as you get older, understanding capital gains tax can help you create an investment strategy that minimizes your tax obligation.
Read the full article or skip to a specific section:
- What Is a Capital Gains Tax?
- Investor Age Does Not Affect Capital Gains Taxes
- Capital Gains Taxes and Seniors
- Understanding the Over-55 Home Sale Exemption
- Deferring Capital Gains Tax With a 1031 Exchange
What Is a Capital Gains Tax?
The capital gains tax is a levy on any profit an investor makes upon selling a capital asset. Capital assets include various investments, such as real estate property, stocks, bonds, digital assets, precious metals, and jewelry. You have capital gains when you sell any of these investments for a higher price than your adjusted basis in the asset. Your adjusted basis is the cost basis of the asset adjusted for the various events that occurred during its ownership. The Internal Revenue Service (IRS) taxes these gains just as it taxes ordinary income.
Capital gains are either realized or unrealized. When an asset you purchased is now worth more on paper than what you paid for it, you have an unrealized gain because you haven’t yet sold it. You have realized capital gains as soon as you sell the asset and make a profit. However, if you sell an asset for less than your adjusted cost basis, you have a realized capital loss instead of a realized capital gain.
The capital gains tax rates vary depending on how long the owner held it. The IRS considers the capital gain long-term if the investor holds the asset for longer than one year before selling it. Any capital gains made on the sale of an asset or property held for one year or less are short-term.
Long-term capital gains tax rates range from 0% to 20% of the realized profit from the sale, depending on income and how you file taxes. Short-term capital gains taxes range from 10% to 37%. A capital gains tax calculator can determine the amount of taxes investors owe on the sale of a real estate property.
Investor Age Does Not Affect Capital Gains Taxes
An investor’s age does not by itself affect any capital gains taxes the IRS expects them to pay upon the sale of an asset. However, you can reduce your capital gains tax obligation in other ways. The length of time you hold an investment can significantly impact the capital gains you owe. If you own a property for at least one year, you pay long-term capital gains taxes, which may be less than short-term capital gains taxes depending on your tax bracket.
Some investors use capital losses, which occur when an asset is sold for less than its adjusted cost basis, to reduce their tax obligation further. Taxpayers can offset their taxable capital gains for the year by the total capital losses they incurred. In this case, they can claim a deduction on their taxes of the total net loss or $3,000, whichever is less. If the loss is more than $3,000, taxpayers can carry the loss into future years.
Because taxes can be complicated and detailed, it is critical for investors to work with a tax consultant before purchasing a property and during the selling process to understand how capital gains tax might affect their investment.
Capital Gains Taxes and Seniors
Although you will have to pay capital gains tax at any age, you may be able to benefit from a sort of capital gains tax exemption by using a tax-advantaged retirement plan. If you have a certain type of retirement account and are qualified to take withdrawals, you might be able to avoid paying capital gains tax on qualified distributions.
Many people have two primary sources of income during retirement — distributions from retirement accounts and Social Security payments. The IRS taxes retirement accounts differently based on their type. For example, traditional individual retirement accounts (IRAs) aren’t taxed until you take a distribution. These accounts allow your investments to grow tax-free and are called front-end tax-advantaged accounts. However, once you start taking distributions, the amount is fully or partially taxable and could be subject to capital gains taxes.
However, a Roth IRA operates differently. These accounts are back-end tax-advantaged, so account owners must pay taxes when they make contributions. The benefit of this type of account is that qualified distributions from Roth IRAs aren’t subject to taxes. With a Roth IRA, you may be able to make withdrawals later in life and avoid paying capital gains taxes on any profit your account has generated.
This situation creates a form of capital gains exemption that only applies to people who can take qualified distributions. To count as a qualified distribution, a distribution from a Roth IRA must typically be made after the date the account owner reaches age 59 ½ or five years after the first contribution was made.
Understanding the Over-55 Home Sale Exemption
At one time, there was an age-related capital gains tax exemption in effect which allowed people over the age of 55 to exempt a certain amount of capital gains realized on the sale of their primary residence. This law was referred to as the over-55 home sale exemption. This capital gains tax exemption was in effect to provide taxpayers some relief from the tax burden when they sold their homes. To qualify for this exemption, the seller or one of the title holders had to be 55 on the day they sold their residence.
However, the passing of the Taxpayer Relief Act of 1997 abolished that exemption. Although you must now pay capital gains tax when selling investment properties, the over-55 home sale exemption has been replaced by a home sale exemption that can benefit taxpayers of any age. Homeowners who realize a capital gain on the sale of their primary residence might qualify to exclude up to $250,000 of that gain from their income or $500,000 if they are married and filing jointly.
The Taxpayer Relief Act of 1977 eased the sale tax burden for millions of taxpayers selling their primary residence. To qualify for this exclusion, taxpayers must have owned their home and used it as their primary residence for a total of two years out of the five preceding the sale.
Deferring Capital Gains Tax With a 1031 Exchange
If you want to learn how to defer capital gains tax on real estate, completing a 1031 exchange is one option. A 1031 exchange is a tax-deferred exchange from Section 1031 of the Internal Revenue Code that allows investors to use the funds from the sale of one investment property to purchase another. When investors perform a 1031 exchange, they defer capital gains tax on the sale of the property.
If the investor purchases a replacement property of the same or greater value as their relinquished property, they can defer taxes indefinitely until they sell a property without using a 1031 exchange. There is no limit to the number of 1031 exchanges an investor may perform as long as they follow the strict exchange rules. Upon the investor’s death, any deferred capital gains taxes are erased, and the investor passes the properties to their heirs on a step-up basis equal to the fair market value at the time the investor passed away.
Learn More With 1031 Crowdfunding
While investors can defer capital gains taxes, no capital gains tax exemptions for seniors are available. However, investors may use various strategies to lower these taxes. Holding a property for at least one year, offsetting capital gains with capital losses, investing in a tax-advantaged retirement plan, and performing a 1031 exchange can all reduce your capital gains tax burden.
Wherever you are in your investment journey, 1031 Crowdfunding provides offerings that can help you reach your financial goals. Registering for an investor account with 1031 Crowdfunding gives you access to our wide selection of vetted real estate properties for 1031 exchanges. The management team of 1031 Crowdfunding has over $2.2 billion in combined real estate transactions and the experience to help you navigate your real estate investment. To learn more about our offerings, register for an account today.
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