Real Estate Tax Sale Law
Real estate tax law at the federal level is administered by the Internal Revenue Service. Many state tax codes follow the primary concepts applicable to federal tax on real estate, although the tax rates are different. Local taxes on real estate are most often in the form of transfer taxes, which are similar to sales tax. By and large, the taxes on real estate sales focus on the concepts of taxable or capital gain, depreciation and homeowner exemptions.
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Taxable Gain
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Simplified, capital gain is sales price (including commission and closing costs) less the original purchase price (which also incorporates closing costs), less the cost of improvements, plus claimed depreciation. For example, if an investor purchased a rental property for $260,000, made $40,000 in improvements, claimed $20,000 in depreciation and then sold the property for $320,000, he would owe taxes on $40,000 of capital gains ($320,000-$260,000-$40,000+20,000=$40,000). Depreciation is a tax deduction available to business or rental property.
Home Sales Tax Exemption
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As of 2010, if you owned your home for at least two years and lived in your home at least two of the last five years, the first $250,000 (if you are single) or $500,000 (if you are married) of capital gain is not taxed. The remaining capital gain, if any, is taxed at a rate of between zero and 15 percent depending on which tax bracket you fall into.
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Federal Taxes
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Profits on real estate held less than one year are taxed at the same rate as ordinary income. These rates vary between zero and 35 percent. Capital gains are taxed at a flat rate of 15 percent for property held more than a year, for everyone in a tax bracket over 15 percent. For taxpayers in the 10 and 15 percent tax brackets, the capital gains rate is zero. (Note these rates are as of 2010. Current capital gains laws are set to expire in 2011.)
State Taxes
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Different states have different rules. Some states have no tax on the sale of real estate. Others have the equivalent of a state capital gains rate. Still others have a transfer tax. For those that do have a tax, it is not uncommon to have some estimate of that tax taken out of the proceeds at the sale closing.
Transfer Tax
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Local taxes in real estate sales, whether for your home or a rental property, typically come in the form of transfer taxes. As of 2010, 35 states also had a transfer tax. This tax is generally a small percentage of the sale price. In some places the transfer tax is paid by the seller. In others it is paid by the buyer.
1031 Exchange
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Section 1031 of the IRS code allows you to sell a rental property (and some other assets) without taxes so long as the profits go directly into the purchase of another property. This is called a "like-kind" or 1031 exchange (named for the code section). Most states also bypass imposing taxes on a 1031 exchange. There are many rules that guide the 1031 process. Among them is a requirement to have a third party hold the profit prior to your replacement purchase and very strict time requirements for identifying and purchasing the replacement property.
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