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Tax Liability on Real Estate Sales

Real estate ownership often represents an individual’s or couple’s largest asset, and its sale can significantly impact their tax liability. This is among the key reasons that clients seek our help. We help them by researching and gathering information related to expenses and coordinating with related professionals to help minimize that tax liability.

What Impacts Tax Liability

For our clients, common factors impacting their tax liability on property sales include:

  • Timing of sale (during the owner’s lifetime or after death)
  • Duration of ownership (affects the exemption)
  • Cost basis relative to the selling price
  • Ability to offset gain with losses on other assets
  • Commercial use of property
Timing of Sale

A determining factor for the tax liability on the appreciation of the property is the timing of the sale.

Property sold during the owner’s lifetime incurs a tax liability (less the applicable capital gains tax exemption) on the appreciated value of the property compared with the cost basis (e.g., the purchase price plus any qualified capital improvements).

Conversely, the cost basis is brought up to the current market valuation (aka step-up valuation) for property sold after the owner’s death. If the property is sold by the heir(s) shortly after the owner’s death, the tax liability is zero or minimal. We often help clients hire an appraiser to get that date-of-death valuation.

Duration of Ownership

The IRS time threshold for qualifying for the capital gains tax exemption is relatively low. Per the Taxpayer Relief Act of 1997, the first $250,000 for single-filing taxpayers and $500,000 for joint filers is excluded from the gain on the sale of a primary residence.

Offsetting Capital Gains
Cost Basis Relative to Selling Price

Given the significant impact of capital improvements on the tax liability, it’s essential to differentiate between improvements and repairs (which do not increase the property’s cost basis). IRS Publication 523 – “Selling Your Home,” which states that “improvements add to the value of your home, prolong its useful life, or adapt it to new uses,” is a handy reference guide.

In consultation with our clients’ accountants, we identify whether there is a need to document improvements. We help clients document such expenses because, even if the owner kept meticulous records, that can be a time-consuming and challenging project for real estate purchased long ago.

If the owner did not keep records – physical or digital files of receipts for products purchased and invoices for services as the costs were incurred – then the task is even more challenging.

With no property records, or if there’s been a loss of stored documents through theft, fire, flood, or a security breach, there are ways to find the information needed to provide to the accountant:

  • Ask your accountant for a guideline of expenses relative to the selling price and years of ownership.
  • Consult the IRS list in IRS Publication 523 for the types of expenses to document.
  • Track down contractors and other vendors to obtain at least a ballpark of project timing.
  • Consult other financial records to attempt to document improvement-related payments and purchases.
Offsetting Gain with Losses on Other Assets

We recommend to clients that, when they inform financial advisors and accountants about the sale of their home, they discuss whether and how to offset the gain. This can often be done through losses on assets they’ve held longer than one year. Since all such capital gains and losses are reported on IRS Schedule D, working on the balancing of gains and losses is beneficial.

Sale of Commercial Property

When a rental property is sold, depreciation claimed in previous tax returns will affect tax liability. While the depreciation deductions of the purchase price and expenses will have been beneficial year-to-year, they will lower the cost basis. Your tax preparer will help you determine how much of a capital gains liability there will be.

Alternatively, your accountant or financial advisor might suggest minimizing the tax liability on the sale of investment property through a 1031 exchange. This strategy entails rolling the sale’s entire proceeds into a like-kind replacement property. Qualifying for a 1031 exchange involves some complicated rules, so be sure to seek expert advice.

The potential tax liability on property sales can be an obstacle to rightsizing living situations. Eddy & Schein Group is here to help with identifying the financial issues and assisting with documentation.

Eddy & Schein Group helps:

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Serving the Tri-State Area

Eddy & Schein Group helps:

Seniors and their Families
People Facing Life Transitions
High-Net-Worth Individuals
Young Adults and Families
Legal & Tax Professionals
and their Clients
Tell us what you need.
Call for a free phone consultation.

Serving the Tri-State Area

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