Definition of Capital Gain and Equity in Regard to Real Estate
Real estate is full of jargon such as cash-out refinance, loan-to-value and PITI. Two key terms worth knowing are capital gain and equity. A capital gain is the profit you make on the sale of real estate and is treated differently from regular income at tax time; equity is the value of your home unencumbered by your mortgage.
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Identification
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If, for example, you have a $120,000 home and your mortgage is $65,000, you have $55,000 in equity in your home. Your mortgage payments may increase your equity, but fluctuating home prices can also affect it. If the market drops and your home is worth only $90,000, your equity becomes $35,000. In a good market, however, rising values can increase your equity; if your home value goes up to $150,000, that's a $30,000 increase in your equity.
Significance
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Equity is important if you're taking out a mortgage, refinancing or applying for a home equity loan: Lenders prefer you have at least 20 percent equity in the property, the Lending Tree website states. That means on $100,000, you'd need a $20,000 down payment to get a good interest rate. In a really bad housing market, some homeowners end up with negative equity: Their home is worth less than the mortgage. This can prevent them from refinancing, since a new mortgage would be worth more than the house.
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Size
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Money from the sale of real estate, like stocks and other assets, is treated as a capital gain by the IRS, which usually means a tax rate lower than that for other types of income. The tax is levied on the size of your gains, the difference between the sale price and what the IRS calls the "basis." The basis is the original purchase price plus the cost of the sale -- real-estate agent fees, for instance -- and improvements to the property. If you bought the home for $60,000, for instance, then spent $10,000 to add a wing, the basis would be $70,000.
Considerations
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In order to refinance or take out a home equity loan, you'll need to know how much equity you have in the property. This will probably require you to hire an appraiser to estimate the current market value of the house. You may also need an appraisal if you want to sell a house you've inherited: The capital gain basis will be the fair market value at the time it came into your possession, rather than the price the deceased paid for it.
Potential
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Selling real estate at a loss may enable you take money off your taxes, the IRS states. When you sell investment assets for less than the basis, you can claim a capital loss instead of a capital gain; you can deduct at least part of that from your taxable income in the year you made the sale, then carry over any remaining loss to the following year. You can only do this with investment property, however, not your personal home.
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References
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