How can real estate transfer taxes be optimized?
If you buy a real estate investment or rental home, the transfer taxes can be deducted as a work expense. On the flip side, if you buy a primary residence, the transfer tax cannot be deducted.
Here's the good news: Transfer taxes can save you money down the line. The transfer tax becomes part of the cost basis of the property. To make this easier to understand, let's break down what cost basis means. Here's how you calculate it:
- Take the price you paid for your home.
- Add the cost of transfer taxes, title insurance, and any improvements you've made to the home, such as putting in new windows, renovating the bathrooms, or adding new appliances.
- Subtract the amount that the home has depreciated, if applicable.
The final number is your cost basis.
When a home closes, the seller typically needs to pay capital gains tax. This is a tax on the home's increase in value. To determine the capital gains tax on your property, subtract your cost basis from the home's sale price. If your property lost value, you can deduct the difference between your capital losses and capital gains on your tax return. There are some limitations, however. The IRS limits the deductible loss to $3,000 per year. If you're married and file separate tax returns, your loss is limited to $1,500.
It's also important to note that capital gains taxes and transfer taxes aren't the same. If you've lived in your home less than two years, you may need to pay both.
Most states assess capital gains tax on the difference between your cost basis and what you sell the home for. The higher your cost basis, the lower your capital gain. This means you'll pay less in capital gains tax when the property is sold. Let's break that down in an example.
Say you buy a home for $400,000. Several years down the line, you put the house up for sale and it sells for $700,000. Your capital gain on this property is $300,000.
As a general tax rule, if you're filing taxes as single, you pay taxes on gains that exceed $250,000. This applies to all primary residences, regardless of the state the property is in. If you file jointly as a married couple, you need to pay taxes on gains that exceed $500,000.
Using the example above, a married couple wouldn't pay capital gains tax because their capital gain is below the $500,000 threshold (it's $400,000 in the example above). If you file as single, however, you'd pay capital gains tax on $50,000 (the $300,000 profit from the sale of the house minus your $250,000 cost basis).
If you spent $10,000 in transfer taxes when you initially purchased the $400,000 property, that amount is applied to your home's cost basis. So your cost basis is adjusted to $410,000. That means you netted a profit of $290,000. Take out the $250,000 deduction, and you're taxed on the remaining $40,000.
Because you spent $10,000 in transfer taxes, you won't be taxed as heavily on capital gains, saving you money in the long run. Pretty cool, right?
Is it always called real estate transfer tax?
This varies. Some states and cities call it deed tax, deed transfer tax, mortgage registry tax, or stamp tax.
Who pays the transfer tax?
Real estate transfer taxes can be paid by the buyer, seller, or both. It varies based on the real estate market and the state where the transaction takes place. The seller typically pays the tax in most states.