Do you know what tax you’ll pay when you sell your house or shares of stock? Probably not. It’s hard enough to calculate the capital gain, and once you’ve done so with new tax provisions it’s harder than ever to figure out what tax you’ll pay.
Basis and Capital Gain Calculation
To start off with the basics, when you sell property the capital gain is the difference between what you receive and the property’s “basis.” The basis starts out as what was paid for the property, but it can be adjusted in two ways. First, if the property is real estate, you can add to the basis the costs of improvements. For instance, if you bought a house for $300,000 and spent $100,000 putting on an addition, the new basis will be $400,000 ($300,000 + $100,000).
The second adjustment has to do with inherited property. If the house was actually purchased by your parents and you inherited it from your mother, the new basis would be the value on her date of death. If by then, the value had grown to $600,000 and you sold the house for that amount, you would have no gain and no tax would be due. If, on the other hand, your mother transferred the house to you during her life as a gift, you would have received it with her basis — known as a “carry over” basis — of $400,000 and realized $200,000 of gain upon its sale.
These rules also apply to shares of stock and other capital items, such as furniture and artwork. It’s often better to receive these as an inheritance rather than as a gift, especially given the higher capital gains tax rates on collectibles discussed below.
Personal Residence Exclusion
The tax code permits owners of homes to exclude up to $250,000 of capital gain ($500,000 for a married couple) if they have owned and lived in their home for at least two years out of the five years before a sale. So, if your mother transferred her house to you as a gift and then you moved in for at least two years prior to its sale, then you wouldn’t have to pay taxes on the $200,000 of gain.
The Tax Rate
Once you have determined the amount of gain, the hard part comes, and it’s gotten much harder in recent years because the tax on capital gain is now graduated based on income. Following are the federal tax rates for capital gain for property owned at least a year before its sold (so-called “long-term” capital gains tax rates):
Income |
Rate |
|
$0 – $36,250 (single) $0 – $72,500 (married) |
0%
|
|
$36,250 – $400,000 (single) $72,250 – $450,000 (married) |
15%
|
|
More than $400,000 (single) More than $450,000 (married) |
20%
|
|
Special rate on collectibles (art, antiques, etc.)
|
28%
|
On top of these tax rates, beginning in 2013 those with income above $200,000 (single) or $250,000 (married, filing jointly) must pay an additional Medicare tax of 3.8% on unearned income, in effect adding an additional capital gains tax bracket for those with income above these levels.
Most states also charge taxes on capital gains. In Massachusetts, the tax rate is 5.25% except on collectibles, which have a tax rate of 12%. So, for Massachusetts residents the combined tax rate on collectibles can be as high as 43.8%, a strong argument for passing them on to heirs through one’s estate rather than as a gift during life, since this will give them a so-called “step up” in basis.
But back to non-collectibles. As you can see, the federal tax rate will differ greatly from zero to a 23.8% of the gain depending on the seller’s tax bracket. (Plus 5.2% in Massachusetts, for a top bracket of 28%.)
For those in a lower bracket, it can make sense to “harvest” gains every year by selling some stock, but not so much that it pushes you into a higher bracket. (Consult with your accountant first!) If you really do want to own the stock, you can always buy it back again after its sale with the new basis being the purchase price. For example, if you own stock worth $40,000 for which you paid $10,000, it has gain of $30,000. If you sell it before the end of the year and your other taxable income is below $40,000 (for a couple) you will have to pay no tax on the gain. If you subsequently repurchase the stock for $40,000, that will be its new basis, permitting you to sell it in future years with less concern about the tax consequences. (But don’t sell it too fast; if you sell it within a year of purchase it will be treated as short-term capital gains and subject to a higher tax rate.)
Conclusion
Is your head spinning? In short, the tax rate on capital gains depends on the type of property being sold, how long it’s been owned, whether or not it was inherited, and other income of the seller. All of this means there are planning opportunities for those with property containing gain. Also there are opportunities for accountants and attorneys to sell their expert advice on this topic. Wouldn’t a simpler system make more sense for all? (I’m sure even most of those attorneys and accountants would give up some income for a more straightforward tax code.)
Click here to learn about the capital gains tax in 2014.
