If I Sell Property at a Gain, do I owe Tax?

The answer is maybe!

Only tax law is strange enough to have three different answers to the same question. Let us wade through the murky water together and I will give you some examples of different answers to the same question. The first factor to consider is, did you own the property you sold for more than one year?

Exception #1 – Tax law differentiates between property held more than a year and property held a year or less. If you held the property more than a year, it is taxed at a more favorable tax rate.

Exception #1A – If you inherited property and sold it one month after you received the property from the person who died, it is the same as if you held it more than one year, and so you get the lower tax rate. So how much is the tax savings from holding property more than one year? If you happen to be lucky enough to be in the 10- or 15-percent tax bracket (taxable income below $36,251 for singles or married filing separately, $72,501 for married filing jointly, or $48,601 for head of household filing status) the tax rate is zero on the gain, so the answer to the question do you owe tax on the gain, is no you do not owe tax on the gain if you held the property more than a year, and were in the 10- or 15-percent tax brackets. If your taxable income places you in the 25-, 28-, 33- or 35-percent tax brackets the tax rate is 20-percent on the gain (lower than the 25-, 28-, 33- or 35-precent tax rate) and if you are unlucky enough to be in the 39.6-percent tax bracket (over $400,000 taxable income for single, $225,000 for married filing separately, $450,000 for married filing jointly, or $425,000 for head of household filing status) the tax rate is 25-percent of the gain (lower than the 39.6-percent tax rate). Some of these tax savings can be reduced by the alternative minimum tax, but that is another tax we will not discuss in this article. If you held the property more than a year, and were not in the 10-percent or 15-percent tax brackets, you will owe tax on the gain, but at a lower tax rate. Now what happens if you held the property less than one year (or did not inherit the property)? All gains in this case are taxed at your normal tax rate (no lower tax rates for anybody).

Exception #2 – What if I sold property (stocks, mutual funds, etc.) at a loss last year, and had more losses than gains? When you have losses that exceed gains, you are allowed to deduct $3,000 of losses in excess of gains in that year. Losses in excess of gains are then carried forward to offset any gains in the following years. So if you had $8,000 of 2012 stock losses in excess of gains, you could have deducted $3,000 of those losses on your tax return in 2012, and the remaining $5,000 of losses would have been available to eliminate up to $5,000 of gains you recognized in 2013. Hence all the rules in paragraph one may be set aside until you consider the carryover of losses from the prior year(s). Unfortunately, when you buy a do-it-yourself tax software program, that program does not know about prior year losses or tax credit carryovers unless you tell the program about them. This is why our firm always asks for a copy of your prior year(s) tax returns so we can ensure you are getting credit for any loss carryovers or credits to help reduce your tax.

Exception #3 – What if the property I sold was my house? If you lived in the house at least two out of the last five years (it was your principal residence, not a vacation home or rental property) you can exclude gain on up to $250,000 for individuals, and up to $500,000 of gain for married individuals filing jointly where neither spouse excluded gain from the sale of another home during the two year period ending on the date of sale. Well, that is nice!! What if I don’t meet the two year ownership and use tests, or I already excluded a gain on another house within the two year period?

If the reason for the sale of your principal residence was due to:

(1) – A job related move where the new job is located more than 50 miles farther from the location of the house that was sold; (2) – to obtain or provide medical care for an individual suffering from a disease, illness or injury; or (3) – unforeseen circumstances due to the occurrence of an event the taxpayer could not have anticipated prior to buying and occupying the home, you can receive a reduced exclusion on the gain on the home sold.

Assume you (a single individual) sold the home at an $180,000 gain, but only lived in the home 18 months. Unless you met one of the move, health or unforeseen circumstances tests, you will owe tax on the $180,000 gain. If you meet one of those three tests, you can exclude 75-percent (18 months/24 months) of the $250,000 available principal residence exclusion or up to an $187,500 gain. Since the gain realized was only $180,000, you will owe no tax.

What if I did not sell any stock or mutual funds, but received qualified dividends or capital gains dividends from the stock or mutual funds? The rules in paragraph one dealing with taxability of long term gains (held more than a year) depending on your tax brackets apply to qualified dividends or capital gains dividends also, so can avoid paying tax, or pay tax at a reduced rate, depending on your tax bracket.

Aren’t you glad you use a tax preparer who is familiar with all the nit-picky rules in tax law?