Capital Gains

Capital Gains Taxes for Long Term Investments 2021

Okay taxes, they should be spoken in the same breath as liver, the dentist, and hernias.  Not to be confused, I am referring to Capital Gains Taxes on Long Term Real Estate Properties for 2021. More specifically, in the real estate market for Hawaii.

I’m not an accountant, but I am a real estate agent and a serial homeowner. I’ve had my share of capital gain payments on real estate but also avoided payments by planning the timing on the property sale.

Real estate in Hawaii is a seller’s market right now and many homes are going for over the asking price. That can add up to a lot of unanticipated gains. Not that gain is a bad thing, it’s wonderful to make a profit. But let’s look at the effects of added gains.

Here are some of the tax highlights a buyer should consider while searching for a new property:

1. Long term capital gains for real estate refers to property held longer than 2 years.
2. The property in question must be a primary residence, and the owner/s must have lived there for 2 of the 5 years. Those 2 years do not need to be consecutive.
3. The rate of the tax is dependent upon how much annual income the owner/s have; as an individual or as a couple.
4. There are different deductions on capital gains depending on whether you own a property as a single individual or as a couple. For a single person, the IRS will deduct $250,000 from your tax liability however, for a couple they will deduct $500,000 after you have determined your cost basis.
5. How do you determine your cost basis, you ask? I think this is the great part. You take the cost at which you purchased the property, add the non-decorative improvements, plus closing costs determined in escrow and (here’s where I come in) add your Real Estate Agents’ commissions. Total these numbers up and you have what is called your cost basis. The goal is to INCREASE your cost basis so that your realized profit on the home will be less.
6. Keep all your invoices for any improvements that you have made to the property, such as:

• Added a pool.
• Remodeled the kitchen.
• Put on a new roof.
• Painted the house.
• Extended the lanai.

You get the idea. In an appreciating sellers’ market, you want to do everything that you can do to INCREASE your cost basis before you sell. This might sound a little counterproductive. I had a client who asked me why he had to spend money to lower his capital gain tax.

Hopefully, the following Case Study will help you understand how the process works.

Robert, a young professional living on Maui, decided to sell his home which he has lived in for 10 consecutive years. The original purchase price of the home was $1,000,000, however, with appreciation his home is now on the market for an asking price of $2,100,000. Wow, a $1,100,000 profit. But how can he reduce his capital gain exposure? Let’s do the math.

SALE OF HOME:                                                                $2,100,000                         

1. Original Purchase Price $1,000,000
2. Home Improvements:

• Outdoor Pool Repair         30,000
• New Kitchen         64,000
• Landscaping         48,000
• Paint Exterior Home         18,000
• New Bathroom         40,000

3. Escrow Closing Costs         12,000
4. Real Estate Commission @6% 126,000   (3% Seller’s Agent & 3% Buyer’s Agent)

COST BASIS:                                                                        $1,338,000                         

Reduced Profit                                                                      $762,000 (subtract cost basis from sale price)              

IRS Single Owner Deduction                                           $512,000 (subtract $250,000 from reduced profit)

IRS Couple’s Owner Deduction                                      $262,000 (subtract additional $250,00 from profits)

So, we can see that Robert’s capital gains exposure as a single homeowner is $512,000. If he had held title to the property as a couple, his exposure would have been only $262,000. The rate at which capital gains are taxed depends on Robert’s annual income level. Let’s say he makes $300,000 annually. Today his federal capital gains tax rate would be at 15%. By increasing Robert’s cost basis, he has reduced the amount of his capital gains exposure.

I know that $262,000 or $512,000 sounds like a chunk of change to pay in capital gain taxes, but subtract either number from the initial profit of $1,100,000 and your after-tax profit is either:

1. $1,100,000 – 262,000= $838,000 (couple as owners) or
2. $1,100,000 – 512,000= $588,00 (single owner)

I hope that this information has helped you. Please know that there are other solutions to avoiding capital gain taxes with the sale of a property; a 1031 tax deferred exchange for example. Consult your favorite accountant for more information on strategies for minimizing capital gain taxes. ALOHA