capital gains tax

Q&A: Capital gains tax

July 5, 2022 By Liz Weston

Dear Liz: I am selling my house. After subtracting all selling costs, stepping up the basis for capital improvements over the years, and using the $500,000 capital gains exclusion from the IRS, I will still have a significant capital gains tax due. Does this tax need to be paid via the quarterly estimated tax in the quarter the house closes, or can I wait and pay the capital gains tax with the yearly tax filing?

Answer: If you are the sole owner of the home, then you can exclude up to $250,000 of capital gains from a home sale. If you’re married then the exclusion amount is doubled to $500,000.

Ours is a “pay as you go” tax system, which means you’re supposed to withhold the appropriate taxes as you earn or receive income. If you don’t withhold enough, you can owe penalties. People who don’t have regular paychecks or who experience windfalls, such as your home sale, may have to make quarterly estimated payments to ensure they’ve paid enough to avoid the penalties.

One way to avoid penalties is to make sure your 2022 withholding at least equals your 2021 tax bill, if your adjusted gross income is $150,000 or less. If your adjusted gross income is more than $150,000, your withholding needs to equal 110% of your 2021 tax bill. Another is to pay 90% of your 2022 tax bill. It’s tough to know what your tax bill is going to be before the year ends, though, so most people choose to withhold based on their 2021 tax bill. If your 2022 bill will significantly exceed your withholding, however, you’ll want to make sure you stash the appropriate cash in a safe, FDIC-insured savings account so it’s available when you have to pay Uncle Sam next year.

Q&A: How previous home sales might affect your capital gains taxes

June 27, 2022 By Liz Weston

Dear Liz: I am selling my house and will not be buying another one. I believe that I know the rules of capital gains taxes in general. However, must I include the capital gains of previous homes, even those experienced many years ago?

Answer: Possibly.

Before 1997, homeowners could avoid capital gains taxes by rolling their profits into another home, as long as the purchase price of the new house was equal to or greater than the home they sold. Homeowners 55 and older could get a one-time exclusion of up to $125,000.

The rules changed in 1997. Now homeowners can exclude up to $250,000 of home sale gains as long as they have owned and lived in the home at least two of the prior five years. A married couple can exclude up to $500,000.

If you have not sold a home since the rules changed, however, any previously deferred gains would lower the tax basis on your current home.

Let’s say you bought your current home for $300,000 prior to 1997. Normally, that amount (plus certain other expenses, including qualifying home improvements) would be your tax basis. If the net proceeds from your sale were $500,000, for example, you would subtract the $300,000 basis from that amount for a capital gain of $200,000.

But now let’s say you rolled $200,000 of capital gains from previous home sales into your current home. That amount would be subtracted from your tax basis, so your capital gain would be $400,000 — the $500,000 net sale proceeds minus your $100,000 tax basis.

Before selling any home, you should consult with a tax pro to make sure you understand how capital gains taxes may affect the sale. You don’t want to find out you owe a big tax bill after you’ve spent or invested the proceeds.

Q&A: How to reduce capital gains taxes on a home sale

May 2, 2022 By Liz Weston

Dear Liz: We’re retired and living in California. We are planning on selling our home, which is paid for, and moving to Tennessee in a couple of years. I think we qualify for a “one time” capital gains exemption. Our home is worth over $1 million and we paid only $98,000 in 1978. We plan on buying a home in Tennessee for around $800,000. Will we have to pay capital gains tax?

Answer: Before 1997, a homeowner could defer paying taxes on home sale gains as long as they rolled the proceeds into the purchase of another home of equal or greater value. In addition, there was a one-time exclusion for homeowners over age 55, who could exclude up to $125,000 in home sale gains.

Those rules were replaced in 1997 with the current law. Now homeowners of any age can exclude up to $250,000 each in capital gains on the sale of their primary residence, as long as they’ve owned and lived in the house for at least two of the previous five years. As a married couple, you can exclude up to $500,000 of gain — but that still leaves you with more than $400,000 of potential capital gains.

The capital gains calculation doesn’t factor in the value of your replacement home or whether you have a mortgage. However, you can use the value of home improvements you’ve made over the years to reduce your taxable gain — assuming you kept those receipts. The IRS defines home improvements as expenses that add to the value of your home, prolong its useful life or adapt it to new uses. Examples would include additions (bedrooms, bathrooms, decks, garages, etc.), heating or air conditioning systems, plumbing upgrades, kitchen remodels and landscaping, among other costs.

Improvements don’t include maintenance required to keep your home in good condition, such as painting, fixing leaks or repairing broken hardware, or improvements that are later taken out. If you put wall-to-wall carpeting and then removed it to install hardwood floors, only the cost of the hardwood floors would count.

Many of the costs you incur to sell the home, such as real estate agent commissions and notary fees, also can be used to reduce the capital gain. You can find more details in IRS Publication 523, Selling Your Home. A big home sale gain can affect other areas of your finances, such as your Medicare premiums, and may require you to pay quarterly estimated taxes. Consider talking to a tax pro before the sale so you know what to expect.

Q&A: How to figure your capital gains tax bite so the IRS doesn’t zap you

April 4, 2022 By Liz Weston

Dear Liz: We had big capital gains this year, and we owe taxes plus a penalty for not paying estimated taxes. Is there a way to plan ahead for taxes since every year is different regarding gains or losses? I know one option is to just pay estimated taxes quarterly based on the previous year’s gains. Apparently the mutual fund companies don’t automatically withhold the taxes.

Answer: Our tax system is “pay as you go,” which means the IRS expects you to pay taxes as you earn or receive income. If you fail to do so and your tax bill is more than $1,000, you may face penalties.

As you rightly note, though, you won’t know what your total capital gains or losses will be until year’s end. You wouldn’t want to pay taxes on a big gain one quarter only to have a big loss the following quarter. You can avoid the penalties by making sure your withholding and estimated tax payments equal at least 100% of the total tax you paid in the previous tax year if your income is $150,000 or less. If your income is over $150,000, your payments and withholding should equal at least 110% of last year’s taxes.

The alternative is to pay at least 90% of the tax you’ll owe on your estimated income for the current year. A tax pro can help you figure out how much you need to pay as well as offer tips for reducing your tax bill.

Q&A: What is the capital gains tax, and how big a bite does it take?

January 17, 2022 By Liz Weston

Dear Liz: We own stocks with enormous capital gains — as in, six figures or more. The tax would be a lot. Any advice on how to limit the tax bite? Our income consists of Social Security and a teacher’s pension.

Answer: Capital gains taxes may be less of a problem than you fear. If your taxable income as a married couple is less than $83,350 in 2022, your federal tax rate on long-term capital gains is zero. (Long-term capital gains apply to profits on stocks held one year or more.) If your taxable income is between $83,350 and $517,200, your federal capital gains tax rate is 15%.

In addition, you may owe state taxes. California, for example, doesn’t have a capital gains tax rate and instead taxes capital gains at the same rate as ordinary income.

Capital gains aren’t included when determining your taxable income, by the way, but they are included in your adjusted gross income, which can affect other aspects of your finances. A big capital gain could determine whether you can qualify for certain tax breaks, for example, and could inflate your Medicare premiums. That’s why it’s important to get good tax advice before selling stocks with big gains.

A tax pro can discuss strategies that might reduce a tax bill, such as offsetting gains with capital losses by selling any stocks that have lost value since you purchased them. You also could consider donating appreciated shares to qualifying charities. If you itemize your deductions, you can deduct the fair market value of these shares. The write-off is typically limited to 30% of your adjusted gross income for the year, although if you donate more you can carry forward the excess deduction for up to five years.

All this assumes that these shares aren’t held in retirement accounts. Withdrawals from retirement accounts are typically taxed as ordinary income and don’t benefit from the more favorable capital gains rates. If the stocks are in an IRA and you’re at least 70½, however, you could make qualified charitable distributions directly to nonprofits and the distributions wouldn’t be included in your income. Again, this is something to discuss with a tax pro before taking action.