Real Estate Capital Gains
Homeowners usually incur a capital gains tax on property sold at a profit. A capital gain is material wealth in the form of money made from the sale of real estate, trusts, corporations, partnerships, or any qualifying tangible possession. The Internal Revenue Service defines a capital asset as property owned for personal purposes or as an investment. Houses, furnishings, automobiles, and stocks and bonds are considered assets. Property owned in conjunction with a business, including real estate used for trade or business purposes, is not considered a capital asset. When an individual sells a possession, the difference between the amount the asset is sold for and the amount an owner initially paid for it is called a capital gain. In the marketplace, assets are bought and sold 24/7; but the U.S. Department of Revenue demands taxpayer accountability and enforces taxation on specific net earnings.
Although the housing market is in a severe slump in the United States, some sellers are making money through real estate sales or by accumulating heir property. Other sellers are letting their properties go at a loss due to the severity of the housing market downturn. Escalating interest rates have left some homeowners holding mortgages that are worth much less than current market prices. Some are fortunate enough to unload these properties, but still fall short of outstanding mortgage balances and cannot recoup money initially invested, or what the IRS terms as the initial cost, or basis, of the property. Whether owners realize net profits or losses, they are required to itemize transactions on the Internal Revenue's Schedule D of Form 1040 Or Form1040NR, "Capital Gains and Losses."
Owners who realize a profit from housing sales must itemize the extra income on Form 1040 and are subject to taxation. The real estate capital gains tax on property is usually assessed at a maximum 25% rate. In real estate sales, 25% can amount to thousands of dollars on the taxable portion of a net capital gain. The IRS may require taxpayers to make estimated payments to settle the capital gains tax on property sold. But paying taxes is older than the Bible. Even Joseph, Jesus natural father, paid taxes in compliance with Caesar's decree. "And it came to pass in those days, that there went out a decree from Caesar Augustus, that all the world should be taxed. (And this taxing was first made when Cyrenius was governor of Syria.) And all went to be taxed, every one into his own city. And Joseph also went up from Galilee, out of the city of Nazareth, into Judaea, unto the city of David, which is called Bethlehem; (because he was of the house and lineage of David:) To be taxed with Mary his espoused wife, being great with child" (Luke 2:1-5). A necessary requirement for Old Testament and modern day citizens, taxes provide much needed revenue to keep city, state and federal governments viable.
The IRS allows homeowners who suffer a loss to itemize and claim a maximum deduction of $3,000. A $1,500 deduction is allowed for married individuals who sell jointly owned real estate, yet file separately. If losses exceed the maximum $3,000 deduction, the Internal Revenue Service may allow filers to carry the loss over future years. Taxpayers file Schedule D of Form 1040 to qualify for certain tax deductions, in the case of a loss, or to pay the capital gains tax on property. Real estate capital gains affect a taxpayer's net taxable income and help determine whether filers qualify for an income tax refund or are assessed a liability. Schedule Ds are also filed with a payment to the federal government if the selling price netted a profit above the taxpayer's basis, or the amount the consumer initially paid for the property. Filers should use a Schedule D when assets have been sold or exchanged and have not been reported on any other form or schedule; to report distributions not included on Form 1040 or Form 1040NR; or to annotate gains from involuntary conversions of personal assets. Taxpayers may also report personal bad debts, such as defaulted promissory notes or loans.
To complete Schedule D and have the Internal Revenue Service assess tax on property sold, filers must include a legal listing of the real estate, date acquired, date sold, and sales price; along with the original purchase price, or basis, and the computed net gain or loss. Owners of multiple real estate holdings must furnish information on each property. Assets held one year or less are listed as short-term gains or losses, while those held for more than a year are listed on a separate section of the Schedule D as long-term.
Computing real estate capital gains is relatively simple. The IRS provides detailed instructions and information in Publications 550 and 544, which may be downloaded from the IRS website. Publication 550, "Investment Income and Expenses," outlines regulations for reporting profits from the sale of investments such as stocks and bonds. Publication 544, "Sales and Other Dispositions of Assets," deals largely with IRS requirements for reporting profit made from the sale or acquisition of real property. Sellers who realize real estate capital gains from the sale of a main residence should reference Publication 523, "Selling Your Home." If IRS publications still leave sellers confused, the best recourse is to seek the advice of a certified public accountant, realtor, local lending institution, or banker. Local Internal Revenue offices may also be able to provide assistance in computing net gains or losses and helping homeowners determine and file estimated tax payments.
Inheritance Tax PlanningIncorporate estate tax planning and even inheritance tax planning into the decision to pass along assets to others, and enjoy the peace of mind that comes from knowing that these funds are going to the persons or organizations which have been specified, rather than being lost to taxation. In the midst of a busy and productive lifestyle, few people want to take the time to consider estate planning. For one thing, this is an uncomfortable reminder that one is not immortal, at least physically. Yet Scripture affirms that "...it is appointed unto men once to die, but after this the judgment: So Christ was once offered to bear the sins of many..." (Hebrews 9:27-28). Another barrier is the fact that few people really understand the process of estate tax planning.
Obtaining professional help in this area is a wise move. However, a person can at least begin to consider some of the aspects of these financial issues on their own. Becoming aware of some issues involved with inheritance tax planning will give a person a basic grasp of issues which should later be confirmed by professional advisors. Planning may also have benefits in spiritual areas as well. In actually setting out lists of assets and planning for their disbursal, a person is led to consider what he or she has done so far with the things which God has given, and whether a change in life direction or priorities is in order.
There is a difference between inheritance tax planning and estate tax planning. An estate tax is one which is levied on an estate if the value exceeds an exclusion allowed by law. A spouse is not subject to this process, for a transfer of assets to a surviving spouse is not taxed. This right of spouses to leave assets to each other is known as the 'unlimited marital deduction'. If the surviving spouse dies, the heirs may be subject to estate taxes if the amount exceeds exclusion limits. Since these taxes can be considerable, it is best to plan ahead so that they can be reduced or eliminated. An inheritance tax is one imposed on those who inherit assets from a deceased person. The value of the property and the relationship to the deceased will determine the rate for inheritance taxes. It may help to remember that the estate tax is one which is imposed on the total value of a person's estate when he or she dies, while an inheritance tax is only imposed on the part of that estate which an heir receives.
At times, plans have been suggested to eliminate the estate tax entirely for a period of time. However, unless new laws are passed, such taxes continue to impose significant liability on estates with large assets. Millionaires are not as uncommon as they used to be, and many people urge that exclusion rates be raised to keep up with inflation. Another proposal seeks to set permanent tax levels, with future allowances for inflation. Others are not satisfied with this and seek ever higher exemptions. Some people see the costs involved in such exemptions as simply adding to the nation's deficit, while benefiting mostly the richest taxpayers. Others believe richer taxpayers should not be expected to fill the deficit hole with the fruits of their labors.
Where does this leave those involved in inheritance tax planning or estate planning? First, consider personal assets. These include a home, investments, pensions, life insurance, and annuities. If assets are worth less than two million dollars, future changes in regulations may not affect much, for exclusions would probably be at least up to that level. Regardless, it is wise to do everything possible to reduce such taxes. Some strategies used by others include creating a Credit Shelter Trust, in which assets up to two million dollars can be sheltered so that a spouse will not need to pay taxes on this portion of the estate.
Gifting is another option for estate tax planning. Twelve thousand dollars a year may be given to an individual without incurring a liability. This gifting is done while the giver is still alive, of course, and may be repeated annually to decrease an estate's value. Also, life insurance policies may be provided so that heirs will not have to deal with any remaining taxes. These policies would need to be put in an adult heir's name, or may be administered through a life insurance trust which the giver sets up.
Blended families have their own inheritance issues to work out. For example, how can one be sure that none of a couple's children are left out of inheritances due to a step-parent's future control of financial matters? Even if relationships are amiable now, financial matters and stressful situations can bring out the worst in some people. For this reason, it is wise to have an experienced lawyer advise one about inheritance tax planning scenarios which may have been overlooked. Even in traditional, uncontested family situations, it is best to have a lawyer to deal with the filing of necessary papers which transfer control of assets and provide for payment of any necessary taxes or fees. Needless to say, the time for dealing with the many matters involved in distributing a person's assets is right now, while he or she is still alive. Read up on these matters, then engage the services of a competent attorney to help make sure that assets are distributed to the people, charities and organizations which have been chosen.