“I would love to sell all my real estate to take advantage of today’s high prices, but I don’t want to pay Uncle Sam a fortune in taxes.” That’s what a widower homeowner and investor, who I estimate is in his seventies, told me a few weeks ago.
Since our conversation, I’ve been wondering if he realizes all the tax-saving choices he has to totally avoid or at least minimize his capital gain taxes if he decides to sell his house and/or investment properties, which he has owned for many years.
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That’s why I decided it would be beneficial to briefly discuss in one place virtually all the major tax avoidance methods that home sellers and investors need to understand. In addition to the well-known methods, we’ll look at some virtually unknown tax-avoidance methods that can save both capital gains taxes and estate taxes. Let’s get started.
We’re all familiar with federal income taxes on earnings received from job wages, interest, dividends, and other fully taxed sources. This is usually called “ordinary taxable income.” It is generally taxed at the highest tax rates, based on a sliding scale — the higher the total ordinary taxable income, the higher the tax rate.
Unless you receive very little or no taxable ordinary income, allowable itemized deductions can significantly reduce the income tax on your ordinary income. Deduction examples include home mortgage interest, residence property taxes, charitable donations, casualty losses, moving expenses, and home business deductions.
In addition to the federal income tax, all states, except Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming, have a state income tax. However, New Hampshire and Tennessee tax only dividend and interest income. State income tax rates are generally much lower than the federal income tax rates, but California, Hawaii, Minnesota, New York, North Carolina and Wisconsin have the highest state income tax rates.
However, federal long-term capital gains, taxed at a much lower tax rate than ordinary income, are earned from profitable sales of capital assets, such as common stocks, bonds and real estate, held over 12 months. If the capital investment asset was owned less than 12 months before sale, its short-term profitable sale is usually taxed the same as ordinary income.
Currently, the federal capital gain tax rate is 15 percent, except for a special 25 percent federal tax rate that applies to “recaptured” (that means “taxed”) depreciation, which was deducted in a prior tax year. Most states also tax capital gain profits, but their tax rules are not always the same as the federal capital gain tax rules. States without capital gains taxes on the sale of capital assets include Alaska, Florida, Nevada, New Hampshire, New Mexico, South Dakota, Tennessee, Texas, Washington and Wyoming.
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