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SALT LAKE CITY — Utah real estate remains a strong seller's market, where big prices can bring sellers big profits. But for some property owners, this could mean a bigger tax bill too.
Homes are considered capital assets and subject to capital gains tax. As values continue to surge across the state, including metro areas clocking some of the largest home price gains in the country, a growing number of homeowners are likely to reap profits that exceed exclusion limits and could see a sizable windfall tax liability when they sell.
Federal law requires Americans to pay capital gains tax on real estate profits that exceed certain thresholds. For instance, with the sale of a primary residence, capital gains are levied on profits over $250,000 for individual tax filers, and $500,000 for taxpayers filing joint returns, according to the Internal Revenue Service.
Capital gains have marginal rates for different income brackets, which begin at 0%, then climb to 15%, then up to 20%.
However, because capital gains are treated as income, the sale of a valuable property could itself cause taxpayers to have to pay alternative minimum tax. The alternative minimum tax kicks in when taxpayers have more income than an exemption amount and make use of common itemized deductions. Though income taxed at the capital gains rates is isolated from the ordinary rate, profits from the sale of a home could trigger an alternate minimum tax, according to Susan Speirs, a certified public accountant and CEO of Utah Association of Certified Public Accountants.
Additionally, because the profit thresholds have not changed since 1997, it has become easier for middle-class households to exceed the exclusion amounts, which tax experts at the Utah Association of Certified Public Accountants say sets the stage for a higher incidence of capital gains taxes.
Large home profits can add complexity to an already intricate system that gets trickier as assets and income expand. For this reason, the Utah Association of Certified Public Accountants recommends that if buyers are concerned that a gain on the sale of their home could increase their tax bill, planning is critical, Speirs said in an interview with the Deseret News.
Being strategic as to how these sales occur allows the taxpayer to utilize the tax statutes more effectively.
–Susan Speirs, CEO of Utah Association of Certified Public Accountants
One way to minimize tax liability is by tracking property improvements, which add to the property's "basis" — the total dollar amount on which the gain is based. By boosting the basis, you effectively shrink the taxable profit upon sale.
However, to be included in the basis the improvements must add value or lifespan to the house. For example, improvements such as kitchen remodels, painting or additions can be added to the basis. But replacing a washer or dryer cannot, Speirs said.
Sellers can also subtract costs associated with the sale of the house, like transfer and appraisal fees along with real estate commissions, reducing the taxable profit further.
Because the exclusion from capital gains can only be realized once every two years, filers with more than one property must time the sale of those assets to take advantage of exclusions.
For owners of investment property — like rental units or commercial buildings — it's increasingly common to implement a 1031 tax exchange, or a "like-kind exchange," which allows sellers to use the profits from the sale of one property toward another that's of "like kind" and thereby defer the capital gains tax.
However, Speirs says sellers considering a 1031 would be wise to consult with a CPA because "real estate transactions with like-kind exchanges is pretty complicated stuff. And the more you get into some of it, the more confusing and unwieldy it is because there's so many twists and turns."
The combination of rising real estate prices and general inflation have led tax advocates to call for a reconsideration of the dollar ceiling on capital gains. A February report from the Congressional Research Service offers policymakers a template for potential changes.
But experts like Speirs don't believe federal leaders will address the issue anytime soon.
While it is possible that capital gains liability could deter sellers and contribute to a tightening market, the underlying issue of slowed home circulation is inventory, according to Speirs.
"The bigger challenge is if a taxpayer sells their home for a huge gain and intends to purchase another is whether there is the inventory at the price point they want to purchase," she said.
Speirs believes that in order to pay the minimum amount of tax, sellers must be strategic about how sales occur in order to utilize tax statutes effectively.
"This is why it's so important to involve your CPA in these property transactions in the planning stages — everyone wants to pay the minimum amount of tax. Being strategic as to how these sales occur allows the taxpayer to utilize the tax statutes more effectively," she said.
