Capital gains tax can be complex, especially when it comes to real estate transactions. Consulting with an experienced and reliable real estate lawyer can help you navigate the intricacies of capital gains tax and ensure you’re taking full advantage of available deductions and exemptions. By understanding the basics and seeking professional advice, you can take steps to minimize your tax liability and maximize your after-tax returns. Here is everything you need to know about capital gains tax.
Capital Gains Tax Explained
Capital gains tax is a levy imposed on the profit realized from the sale of a capital asset. This asset could be anything from stocks and bonds to real estate, collectibles, or even a business. When you sell an asset for more than you paid for it, the difference is considered a capital gain, and it’s this gain that’s subject to taxation.
The capital gains can be classified into two main categories:
- Short-Term Capital Gains
- Long-Term Capital Gains
Short-Term Capital Gains
If you sell an asset within one year of buying it, your profit is considered a short-term capital gain. These gains are taxed at your ordinary income tax rate, which can be quite high.
Long-Term Capital Gains
When you hold an asset for more than a year and then sell it, the profit is a long-term capital gain. These gains are generally taxed at lower rates, making long-term investing a more tax-efficient strategy.
Calculating Capital Gains Tax on Real Estate
When individuals sell a property, they pay a capital gains tax. If their gains are up to $250,000, the tax rate is 50%. For gains over $250,000, the rate increases to 66.67%. They may also have to pay an additional income tax based on their total capital gains and tax bracket.
Corporations and trusts also pay capital gains tax. They are taxed at a flat rate of 66.67% on all capital gains, regardless of the amount.
Let’s break down how capital gains tax is calculated on real estate specifically:
Determine Your Cost Basis
- Original Purchase Price: This is inclusive of the amount you paid to buy the property itself.
- Closing Costs: It is crucial to factor in any fees associated with the purchase, such as legal fees, title insurance, and property taxes.
- Capital Improvements: One should also consider any substantial improvements you might have made to the property that increased its value, such as adding a new bathroom or renovating the kitchen.
Remember: Keeping detailed records of your expenses is crucial for accurate tax calculations.
Calculate the Capital Gain
- Selling Price: This is the amount you received from selling the property.
- Subtract the Cost Basis: Deduct the cost basis from the selling price to arrive at your capital gain figure.
Tip: Understanding the impact of inflation on the value of your property can help you adjust your cost basis and potentially reduce your overall taxable gain.
Apply the Tax Rate
- Long-Term Capital Gains: If you owned the property for more than a year, you’ll benefit from lower tax rates. The exact rate depends on your specific income level.
- Short-Term Capital Gains: If you sold the property within one year of purchasing it, you’ll be taxed at your ordinary income tax rate, which as mentioned earlier, can be significantly higher.
Note: Tax laws can be complex, it’s always wise and recommendable to consult with a tax professional to ensure you’re maximizing your tax benefits.
A Real-World Example
Imagine you bought a house for $200,000 ten years ago. You spent $10,000 on renovations over the years. You recently sold the house for $350,000.
Cost Basis: $200,000 (purchase price) + $10,000 (improvements) = $210,000
Capital Gain: $350,000 (selling price) – $210,000 (cost basis) = $140,000
Since you held the property for more than a year, you’ll be subject to long-term capital gains tax. The specific rate will depend on your income tax bracket.
When Does Capital Gains Tax Apply to Real Estate?
Capital gains tax can apply to various types of real estate, but there is a key exception for principal residences. According to the Canada Revenue Agency (CRA), a property is exempt from capital gains tax if it is owned solely or jointly with a spouse, common-law partner, or any children, provided that the taxpayer lived in it at some point during the year and designates it as their principal residence. However, it’s important to note that only one property can be designated as a principal residence for each family unit in a given year.
Understanding Capital Gains Tax on Joint Property in Canada
Figuring out who has to pay capital gains tax on property shared by multiple owners can be tricky and daunting. The type of ownership you have plays a big role in determining how taxes are handled.
There are two main ways people can own property together: This being a joint tenancy and tenancy in common.
Joint Tenancy: In this structure, everyone owns an equal part of the property. If one owner passes away, their share automatically goes to the remaining owner through a mechanism called the Right of Survivorship. If the property is sold while all owners are still alive, any profits (capital gains) from the sale are shared equally among them. However, if one owner dies before the property is sold, the surviving owner becomes responsible for any taxes on the resulting gains.
Tenancy in Common: This type of ownership allows each person to own a specific portion of the property, which can be equal or different. When the property is sold, the profits are divided based on the proportional representation of each person’s share. For example, if one owner has 70% of the property and another has 30%, they will split any tax on the gains according to those percentages.
Understanding these differences is essential to know who and how much each person will pay regarding capital gains tax when selling jointly owned property.
Who Pays Capital Gains on a Deceased’s Property?
When someone passes away, a final tax return needs to be filed for them. During this process, any property they owned is treated as if it was sold on the day they died, using its fair market value. If any capital gains result from this, those gains are allocated to the deceased’s income, and the estate then pays the taxes on them.
Need Expert Guidance?
If you have questions about capital gains tax on real estate or any other tax-related matter, don’t hesitate to reach out to Rutman & Rutman Professional Corporation. Our real estate lawyers are dedicated to providing top-tier comprehensive and personalized legal advice. We can help you navigate the complexities of tax law and ensure you’re taking advantage of all available mechanisms, deductions and credits.
Contact Rutman & Rutman Professional Corporation today to schedule a consultation.
