Woodbridge VA Real Estate - Prince William County Real Estate

Capital Gains information

What you should know about capital gains

Capital gains taxes: There's more than one rate
Bankrate.com
Money gurus are always preaching long-term investing. Not only will that give you a better shot at earning more, it'll also get you a lower tax rate when you sell.

But exactly what rate you get depends on several things, including when you bought the asset, when you sold it, your overall income level and sometimes what tax-code changes are made in the meantime.

Currently, capital gains may be taxed at 5, 15, 25 or 28 percent or a combination of rates. These tax levels are known as long-term capital gains and apply to assets that you hold for at least 366 days (more than one year). The long-term capital gain tax generally is much lower than what you pay on your regular income.

In fact, it is a taxpayer's income level that generally determines which capital gains rate is owed. If your profit pushes you into a higher bracket, you could possibly be taxed at a combination of rates.

And you could face yet another rate depending upon the type of property you sell.

Rates cut in May 2003 For many years, investors whose overall income put them in the top four income tax brackets faced a long-term capital gains rate of 20 percent, while lower-income investors paid capital gains taxes of 10 percent.

Tax-law changes in May 2003, however, lowered the rates by 5 percent each. Most investors, which generally means folks in the higher income ranges, now find their capital gains taxed at 15 percent. But if you don't fit into this most-common capital gains mold, here's a breakdown of all the tax levels.

Remember, each of these is the long-term capital gains rate. In most cases, that means you have to hold an asset for more than a year before you sell it. If you cash it in sooner, you'll be taxed at the short-term rate, which is the same as your ordinary income tax level and could be as high on 2003 returns as 35 percent.

5 percent rate This capital gains rate applies to taxpayers in the 10 or 15 percent income tax brackets. They will pay a maximum 5 percent long-term gains rate on property held for more than a year.

Lower-income investors get an even better investment sale deal in 2008. That year, these filers will pay no tax on sales of long-term holdings.

This rate still applies to a portion of your gains even if your asset sale pushes you into a higher bracket. For example, if as a single filer your taxable income was $25,000 but you netted another $7,000 from a long-term stock sale, some of that gain would still be taxed at the lower 5 percent capital gains rate even though technically you were bumped into the 25 percent tax bracket.

In this case, $29,050 (the income ceiling for the 15 percent bracket) minus your ordinary income of $25,000 gives you a $4,050 capital gains cushion at the 5 percent level. Only the remaining $2,950 of gain would be taxed at the 15 percent rate applicable to your new, higher tax bracket.

15 percent rate This most-widely-paid capital gains tax rate applies to long-term investments by individuals in the 25 percent or higher tax brackets. When you hear "lower capital gains rate," it generally means this level, because there are few investors with incomes low enough to qualify solely for the 5 percent rate.

25 percent rate This rate applies to part of the gain from selling real estate you depreciated. Basically, this keeps you from getting a double tax break. The Internal Revenue Service first wants to recapture some of the tax breaks you've been getting via depreciation throughout the years. You'll have to complete the worksheet on page 7 of the instructions for Schedule D to figure your gain (and tax rate) for this asset, known as Section 1250 property. More details on this type of holding and its taxation are available in chapter three of IRS Publication 544, Sales and other Dispositions of Assets.

28 percent rate Two categories of capital gains are subject to this rate: small business stock and collectibles. If you realized a gain from qualified small business stock that you held more than five years, you generally can exclude one-half of your gain from income. The taxable remainder is a 28 percent gain. If you've already hired a tax professional to help you sort out the 25 percent rate on depreciable property, she can help you figure this tax, too. Or you can get the specifics on gains on qualified small business stock in chapter 4 of IRS Publication 550, Investment Income and Expenses.

If your gains came from collectibles rather than a business sale, you'll still pay the 28 percent rate. This includes proceeds from the sale of a work of art, antiques, gems, stamps, coins, precious metals and even pricey wine or brandy collections.

Five-year rates disappear ' for now The changes that dropped long-term rates also eliminated (for transactions after May 5, 2003) two capital gains rates that previously had been in effect.

The 8 percent and 18 percent rates existed for investors who were committed for the longer haul. Both of these rates, the 8 percent one for taxpayers in the 10-percent and 15-percent income tax brackets and the 18 percent rate for those in the top four brackets, were applied to assets held for at least five years. By dropping simple long-term (more than one year) rates even lower, the latest capital gains changes supersede the five-year rates.

However, depending on future tax legislation, the five-year rates (as well as the "old" 10 percent and 20 percent long-term categories) might return.

Under the new law, the 5 percent and 15 percent rates are in effect only through 2008. The temporary time frame was included to ensure that the tax cuts didn't produce too much red ink on the federal budget ledger sheet. On Jan. 1, 2009, prior law will reappear if lawmakers do not make any further changes.

So what's an investor to do? Since most people will pay less taxes on their long-term gains thanks to the new laws, financial experts say take advantage of today's lower rates when they fit into your portfolio plans.

But don't forget about the Dec. 31, 2008, deadline. And definitely keep an eye on federal tax-law writers in the interim.

Calculate your capital gains:
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Homes and Capital Gains (Make your taxes diappear)

I've always been enthralled with magic. Sleight of hand... illusion... call it what you will. But when these artists step on stage and make a dove, a rabbit, or even the Statue of Liberty disappear, I'm just completely amazed and astounded. I've always wanted to be able to do something like that myself. And now I can. And you can too.

With the right knowledge, information, and patience, you can make the taxable gain from the sale of a rental property or a vacation home completely disappear -- stick the gain in your pocket and thumb your nose at Uncle Sammy. Poof... gone.

How? Simply convert the property to a primary residence, use it as such for the appropriate period of time, and then sell it for a tax-free gain. Simple as that. Well, it's a bit more complicated, but you can read more about the rules for tax-free treatment on the gain of a principal residence in my series of articles entitled Home Sale Exclusions in the Taxes FAQ area. You'll also want to read more about the rules regarding the home sale gain exclusion in IRS Publication 523 to make sure that you've got all your bases covered. If done correctly, there are some large tax-saving opportunities out there.

How It Works
The key to the entire plan is that you are allowed to sell a principal residence once every two years and exclude up to $250,000 ($500,000 for a married couple) of the gain on the sale. Many of you may be under the mistaken impression that the home sale exclusion is still only "once in a lifetime," or only available to those of a certain age (such as the elderly), or only available if you buy a more expensive home. Those were the old rules, and they no longer apply. If you meet the two-year ownership and use tests for a principal residence, and don't sell more than one principal residence in any two-year period, you can exclude any capital gain tax on the sale (up to the $250,000 or $500,000 limits mentioned earlier). So, to get the maximum bang for your buck, you'll want to understand the rules and have the patience to wait out the two-year residence period. For those of you with substantially appreciated real estate in the form of investment properties or second homes, the tax savings could be worth the wait. Let's look at a few examples.

Rental Conversion
Mary has a residence and a rental property. Both have substantially appreciated in value. Mary sells her primary residence, takes her capital gain exclusion of up to $250,000 on that residence, and decides to move into the rental unit. The rental unit now becomes her primary residence.

Mary resides in the rental unit for another two years to qualify for the ownership and use tests. Mary then sells the property and realizes a substantial gain... of which up to $250,000 can be excluded under the law. Poof... gone.

It makes no difference that most of the appreciation on the second property was realized when it was a rental unit. It also makes no difference that much of the taxable gain is attributable to depreciation that Mary claimed as a deduction against the property in prior years. Mary met all of the tests to exclude the gain and is therefore eligible to do so. Mary has used the tax laws to her advantage. She planned her life to rid herself of some substantial taxes. Nothing illegal or immoral about that.

A Word on Depreciation
It should be noted that all of Mary's gain might not be excluded. Why? Because depreciation taken on the rental property after May 6, 1997 will be subject to "recapture" and tax. But only the depreciation taken after May 6, 1997 will be subject to recapture. Any depreciation taken before that date will be "forgiven" and will be available for the gain exclusion.

Even with this minor inconvenience of recognizing gain on the depreciation claimed after May 6, 1997, the conversion of a rental property to a primary residence likely still makes sense from a tax standpoint. Heck, it seems like a very small price to pay to exclude up to $250,000 (or $500,000 on a married/joint return) of gain.

Retirement Planning
Jack and Jill are thinking about retirement in the near future and want to relocate to a "dream" community in another part of the country. They're afraid that if they wait until retirement to sell their current home, buy a retirement home, and move to the retirement community, that the "hot" real estate market might push the cost of their retirement home out of reach. So, they decide to purchase the property now and rent it out until they finally retire and move. They'll still receive the gain exclusion on their current home when they decide to sell, and they can move into their retirement home and establish it as their new primary residence.

If the retirement area isn't as "dreamy" as they first thought, all they'll have to do is meet the two-year residence test before selling the property to exclude up to $500,000 of the gain (save for any depreciation taken) and move on. Poof... gone. They might make a mistake with the selection of their retirement home, but at least they won't have to add insult to injury by paying any taxes on the gain.

The Reverse Rental Gambit
Bill originally bought his home in 1997 and relocates across the country in 2000 to take a new job stuffing those little fortunes into the cookies. He's not sure if this new job will work out. So, instead of selling his current residence, he decides to rent it out. Bill figures that if he doesn't like stuffing cookies, he can always return to his old home, so renting his home provides a safety net.

Two-and-a-half years later (mid-2002), Bill has climbed the corporate ladder and is in charge of putting those little almonds on top of the cookies. He decides he likes his new job and location and wants to sell his old home -- the one that is now a rental. He does... and is able to exclude up to $250,000 of the gain on the sale (save for the depreciation taken). Poof... gone.

How is this possible? The law says that the property must be used as a principal residence for at least two years during the five-year period ending on the date of the sale of the residence. So even though Bill hasn't lived in the home for the last two-and-a-half years, he did use it as a principal residence for two years during the five-year period ending on the date of the sale. So Bill's gain is subject to the exclusion. Sweet.

These are but a few examples of how the gain exclusion rules can work for you. There are many others. Tax-saving opportunities exist for married people living apart in two separate homes, for people contemplating divorce, for the elderly who may have moved into an extended-care facility for a period of time, and any number of other different combinations. So, make sure that you can be the best magician that you can be. Understand the rules regarding the sale of a principal residence and make those gains disappear. Poof... gone.