What to Know About Capital Gains Tax
After inheriting a home or purchasing a home as an investment, the homeowner is likely going to hear the term “capital gains” tossed around. But what exactly does capital gains mean? Also known as capital gains tax, this is a levy that is calculated based on the difference between the value of a property when acquired and the value when it is sold. Everyone who plans on flipping a home or purchasing an investment property needs to be aware of capital gains and how it will affect their finances moving forward. Here is what everyone needs to know about capital gains tax.
What Qualifies for Capital Gains Tax?
Not every home will qualify for capital gains tax, but the ones that do are known as capital assets. This term also includes things like stocks and bonds, jewelry, or even expensive collections of things like coins, stamps, or even artwork. Homes that qualify for capital gains taxes are typically ones that are inherited and then sold or bought purely as an investment, such as when someone flips a fixer-upper home. However, there are always exceptions, so homeowners should always consult an expert if they aren’t sure if the home they’re selling will qualify or not.
Long-Term and Short-Term Capital Gains
When capital gains are being calculated, one important factor that goes into the calculations is whether the investment is long-term or short-term. Anything that was owned for one year or less before being sold is considered short-term, while anything more than that is considered long-term. Many investors try to deal exclusively with long-term capital gains because the tax rates are less expensive than with short-term capital gains. This is because short-term capital gains are taxed at the homeowner’s ordinary income rate, which can be as high as 37%, while long-term rates can be a maximum of 20%.
Avoiding and Minimizing the Capital Gains Tax
Once homeowners have learned about the different factors that can affect how the capital gains tax is calculated, they can start to plan things in order to save money later on. Here are some of the different ways professional investors minimize their taxes:
- Do long-term investments whenever possible. As mentioned previously, taxes are set up so that long-term investments have a better chance of having lower chances than short-term investments. So, buyers should try to make long-term investments as often as they can.
- Use losses to offset gains. While a financial loss is something everyone wants to avoid, the investor can use their loss to offset other gains they have made if a loss does happen. In the case where a capital loss is larger than a capital gain, the investor can even use up to $3,000 to offset their ordinary income for that year.
- Use tax-deferred retirement plans. For those who have a retirement plan such as a 401(k) or IRA, they can try buying and selling their investments within their plan. This avoids triggering the capital gains tax immediately, but they will still have to pay the taxes when they withdraw the money.
These are just a few of the ways to try to avoid or minimize taxes. For more advice on handling things like these, try consulting an investment advisor.
For anyone who buys and sells property, capital gains is an important thing to be familiar with. Knowing how to navigate capital gains and plan investments can help investors save money while getting the most out of their properties.