If you are selling a home in a red-hot market like Clayton, Missouri, real estate tax planning is imperative, so keep your eyes on the capital gains portion of President Joe Biden’s American Families Plan.
Biden has proposed a capital gains increase for the top 0.3% of households or those making more than $1 million per year. Wealthy Americans at the top of the capital gains bracket could see an increase from 23.8% to 43.4%. While at face value, that might seem to exclude you, it could affect people selling homes that have gained significant value, leaving the sellers with a hefty tax bill.
“The proposed increase in federal as well as state capital gains tax rates could sting [home sellers] on the margins,” certified financial planner Sharif Muhammad, founder and CEO of Unlimited Financial Services in Somerset, New Jersey, told CNBC this spring.
Have no fear, this is not a doom and gloom topic if you plan to sell your home in a hot market for a big profit - many home sellers can avoid paying capital gains by taking advantage of built-in tax breaks and other creative strategies offsetting such gains.
Capital gains explained
To understand how the change could affect you, it helps to know how basic tax laws work when you sell Clayton, Missouri, real estate.
Most people associate capital gains with financial instruments, such as stocks and bonds. But capital gains can also come into play when selling your primary residence or real estate investment property.
When it comes to real estate, the IRS calculates the amount of a capital gain by using the cost basis, which is the original purchase price plus any qualified improvements, as well as commissions and fees you pay when selling the home.
The amount you’ll pay in taxes depends on acceptable deductions, your income, and the sale price of your home.
The IRS excludes up to $250,000 in capital gains from the sale of a home for single taxpayers and up to $500,000 for taxpayers who are married and filing jointly. That means only home sales that result in big profits would be subject to capital gains tax. In some red-hot markets where the prices of homes have shot skyward, however, that becomes a genuine possibility.
Real estate experts offer several examples of how home sellers can be affected. For instance, if a single homeowner earning $200,000 annually purchased a home for $250,000 and sells it for $1.5 million in a super hot market, that would put their income above $1 million for the year, even with the $250,000 exclusion. That would bump them into the 43.4% bracket for that tax year and increase what they owe the government.
With the typical home value of homes in Clayton at approximately $760,936, capital gains taxes can certainly come into play when you sell.
Experts also point out that in order to qualify for the exclusion, the home must be the seller’s primary residence for two out of five years before the sale. The IRS will allow exceptions if residents have to sell their homes due to a health-related reason or because they’ve changed jobs.
There are several factors at work in the St. Louis-area market that could put sellers at risk of facing significant capital gains jumps if the trends continue, including when you sell Clayton, Missouri, real estate. According to Missouri REALTORS, demand for housing remains strong while inventory remains low. The latest data shows a 21% increase in the average sale price in April compared to a year earlier, and this is anticipated to increase in the coming year.
Low-interest rates are helping to drive the demand, as they are in other hot markets, as well as millennials having buying power to get into the market. As an expert in the St. Louis real estate market, I continue to see offers presented well above the list price, which drives the final sale of a home upward, ultimately affecting the seller’s tax basis.
Good news, I expect the boom to continue, so don’t hesitate to connect with me to explore the many ways to offset capital gains in this aggressive sellers market.
Other Biden tax plan implications
The Biden tax plan also calls for eliminating the step-up in basis for inherited assets, including real estate. There is opposition to this from elected officials who want beneficiaries to be able to defer their tax bill as long as they retain the assets.
The “step-up in basis” rule has allowed families to pass property down from one generation to another without paying any tax on the property’s increased value.
The plan would also limit the tax break for the so-called like-kind exchanges, or 1031 exchanges, that allow real estate investors to defer paying taxes on real estate by rolling profits into the next property they purchase. Under the plan, the deferral would end for capital gains over $500,000.
A 2020 survey by the National Association of REALTORS found that about 12% of real estate sales were part of a 1031 exchange from 2016 to 2019.
While Biden’s plan targets the rich, an unintended consequence could be a bigger tax bill for smaller investors. According to that same REALTORS survey, 84% of 1031 exchanges were done by smaller investors, including 47% in sole proprietorships and 37% in S corporations.
Every real estate transaction is different. If you are thinking about selling your home in St. Louis or perhaps selling Clayton, Missouri, real estate anytime in the future, you should meet with a tax planner as well as a real estate expert. We can help you plan options that will offset any windfall gains and resulting tax ramifications from selling a home in a superheated market, whether it is your primary residence or an investment property.
For an excellent experience buying and selling Clayton, Missouri, real estate in 2021, contact me today, Suzie Wells. I am happy to help you find your perfect home.