Tax Implications of Buying or Selling a House
The ramifications of a real estate transaction can be complex and, as such, need to be carefully scrutinized before planning a purchase or sale of a property.
REAL ESTATE TRANSFER TAXES
The real estate transfer taxes are one-time taxes imposed by a state and/or a municipality upon the completion of the transaction transferring real property. In New York, the New York State transfer tax and the New York City transfer tax are typically paid by the seller, although the parties may contractually negotiate different arrangements of these costs.
The New York State transfer tax is charged at the rate of $2 for each $500 of consideration, plus an additional $1.25 for each $500 of consideration for properties with a sale price of $3,000,000 or more. The New York City transfer tax is 1% of the purchase price when the latter is $500 or less, or 1.425% of the purchase price when the latter is $500,000 or more.
The Mansion Tax is an additional transfer tax applied to any unit sold for 1 million or more and is paid by the purchaser pursuant to the following schedule:
- 1% if the purchase price is between $1,000,000 and $1,999,999;
- 1,25% if the purchase price is between $2,000,000 and $2,999,999;
- 1,50% if the purchase price is between $3,000,000 and $4,999,999;
- 2,25% if the purchase price is between $5,000,000 and $9,999,999;
- 3,25% if the purchase price is between $10,000,000 and $14,999,999;
- 3,50% if the purchase price is between $15,000,000 and $19,999,999;
- 3,75% if the purchase price is between $20,000,000 and $24,999,999;
- 3,90% if the purchase price is between $25,000,000.
CAPITAL GAIN TAXES
The taxes on the capital gain are those paid by the seller when the property sold has increased in value since its last purchase. Short-term capital gains arise from the sale of a property held for less than one year and are taxed as ordinary income, with rates that can get as high as 37%; long-term capital gains are taxed at 0%, 15%, or 20% rate, depending on the annual income of the single taxpayer or the married couple filing jointly, although the new Biden administration is considering raising long-term capital gains taxes to a 39.6% rate for individual earning $1million or more.
Often sellers manage to exploit a very attractive exemption on capital-gains taxes: if the seller has used the property as its principal residence for at least two years in the five years preceding the sale (the two years do not need to be consecutive), the first $250,000 of an individual’s capital gains on the sale, or the first $500,000 of a married filing jointly couple, is excluded from taxable income. The costs of any improvements made can be added to the amount exonerated. This exemption can be used only one time every two years.
1031 EXCHANGE
For those that held real estate not as a primary residence – and therefore for investment purposes – there is another tool available to postpone (potentially indefinitely) the payment of capital gains taxes. The 1031 exchange is technically a “like-for-like “exchange because the taxes on the gain are deferred when the proceeds from the sale are invested into a similar property. The closing on the new purchase must be completed within 180 days from the sale. Seasoned investors use the 1031 exchange to obtain superior equity build-up without paying taxes on it. With the 1031 exchange and the tax deferment, sellers can also wrap in the closing costs, title fees, broker fees, attorneys’ fees, and transfer fees from the sale price, which can save a significant amount in taxes.
It is worth pointing out that a 1031 exchange can be done with a step-up in basis on inherited property, which achieves the result of passing down the property to heirs.
FIRPTA
Under the Foreign Investment in Real Property Tax Act (FIRPTA), for properties whose sale price is $300,000 or more, when the seller is either a non-resident alien or a foreign legal entity, the buyer is required to withhold either 10% (when the sale price is between $300,000 and $1,000,000 and the buyer intends to use the property as a residence) or 15% (when the sale price is $1,000,000 or more or when the buyer does not intend to use the property as a residence) from the sale proceeds and to send the amount withheld to IRS within 20 days after closing. If the foreign seller does not realize capital gains on the sale, it will be entitled to receive a full or partial refund from the IRS.