Strategic Ways to Save Taxes When Transitioning to Your Next Property in California In 2023
Investing in real estate is a significant financial undertaking, and when it’s time to sell a property and move to the next one, understanding the tax implications can be complex. However, with strategic planning and an understanding of tax laws, you can potentially save a substantial amount on your taxes. This article will explore the different strategies available to property owners in California, focusing on capital gains tax, transfer taxes, and the unique implications of selling an inherited home.
Understanding Capital Gains Tax
In real estate, capital gains refer to the profit made when you sell a property for more than you purchased it. For example, if you bought a home for $200,000 and sold it for $500,000, your capital gain would be $300,000. In California, these capital gains are subject to taxes at both the state and federal levels.
California’s Franchise Tax Board (FTB) taxes all capital gains as regular income, with rates ranging from 1% to 13.3%, depending on your tax bracket. At the federal level, capital gains can be either short-term or long-term. Short-term gains apply when you sell an asset within a year of purchasing it, and they’re taxed as ordinary income. Long-term gains, on the other hand, apply to profits made from selling an asset you’ve owned for at least a full year.
However, both the IRS and FTB offer capital gains tax breaks for homeowners who meet certain conditions. To qualify for the maximum capital gain exclusion of $250,000 for single filers or $500,000 for joint filers, you must meet the following criteria:
The home being sold is your primary residence.
You’ve owned the home for at least two years in the five-year period before selling it.
You’ve lived in the home for at least two years within the five-year period before selling it. The years of residency don’t need to be consecutive.
You haven’t acquired the home through a like-kind exchange (also known as a section 1031 exchange) within the last five years.
You haven’t claimed the exclusion on another home in the last two years.
You aren’t subject to expatriate tax.
If you don’t meet all these conditions, you may still qualify for a partial exclusion of gain. This is applicable if the primary reason for selling your home was a change in workplace location, a health issue, or an unforeseeable event.
One of the most effective strategies to defer capital gains taxes when selling an investment property is through a 1031 exchange, also known as a “like-kind” exchange. This IRS provision allows you to reinvest the proceeds from the sale of an investment property into a similar or “like-kind” property while deferring capital gains taxes. This strategy essentially allows your investment to grow tax-deferred, and there’s no limit on how many times you can perform a 1031 exchange.
However, 1031 exchanges come with stringent rules and timelines. For instance, you must identify potential replacement properties within 45 days after the sale of your old property and complete the purchase within 180 days. Moreover, you must use a qualified intermediary to facilitate the transaction. The intermediary holds the proceeds from the sale until they’re used to buy the new property, ensuring you don’t have access to the money, which would trigger a taxable event.
Selling an Inherited Property
Selling an inherited property in California has unique implications. While there’s no estate or inheritance tax in California, you do inherit any outstanding debts attached to the property, such as a mortgage. When selling an inherited home, the most significant difference lies in capital
Inherited properties benefit from a “stepped-up basis,” which means that the home’s value is adjusted to the current market value at the time of the previous owner’s death. This adjustment can greatly reduce the capital gains taxes you might owe if you decide to sell the inherited property. If you sell the property at the stepped-up basis value, you won’t have to pay capital gains tax. However, if the property appreciates in value after you inherit it and you then decide to sell, you’ll need to pay capital gains tax on the difference.
California Transfer Taxes
Transfer taxes are transaction fees applied to the sale of any land or real property. In California, the documentary transfer tax varies depending on the location within the state. The law allows general law counties and cities to charge 55 cents per $500 of property value or the amount paid ($1.10 per $1,000). However, charter counties or cities can increase this amount. The seller usually pays the transfer tax, but it can be a point of negotiation during the transaction.
Property taxes are another consideration when selling a property in California. The annual property taxes in California can be paid in two installments. The first installment is due on November 1 and becomes delinquent on December 10. The second installment is due on February 1 and becomes delinquent on April 10. Once a home is sold, the seller is no longer responsible for its property taxes.
Other Selling Expenses
When selling a property in California, other expenses can impact your bottom line. These include title fees, settlement fees, and agent commissions. Understanding these costs and strategically planning for them can help you make the most of your real estate investment.
In conclusion, understanding the various strategies to save on taxes when you are ready to move on to your next property is vital. From leveraging the home sale tax exclusion to understanding the benefits of 1031 exchanges and opportunity zones, there’s a wealth of tactics at your disposal. Employing the stepped-up basis principle or considering the tax implications of home improvements and selling costs can also greatly impact your tax obligations.
However, every situation is unique, and tax laws can be complex. Therefore, it’s always best to consult with a tax professional to understand the best strategies for your specific situation.
Intempus Realty is here to help you navigate through the intricacies of selling your property and moving on to your next. We pride ourselves on our knowledge of real estate and tax implications, aiming to provide the best advice tailored to your situation. Don’t hesitate to reach out to us at Intempus Realty for further consultation and assistance with your real estate transactions.
Remember, a successful transition to your next property doesn’t just happen—it’s planned.