Home in the Santa Cruz Mountains

Santa Cruz real estate investments can be a goldmine. However, Santa Cruz homes and commercial real estate properties also attract CGTs (capital gains taxes) that eat into your profits. However, owners of Santa Cruz Properties can use some tactics (legal, of course) to minimize or avoid capital gains taxes on real estate altogether so they can keep much of their sale proceeds.

Capital Gains Real Estate Tax?

Are you one of those with homes for sale in Los Gatos, CA, Capitola, Felton, Aptos, Scotts Valley, Soquel, and other locations known for high-value f and across the state? If so, you must be ready for your sale's potentially higher capital gains and tax implications.

Capital gains taxes are primarily Federal Government taxes. To understand capital gains tax when selling a home or an investment property, let's begin by defining capital gains and losses.

  • Capital gains on selling a home or any other property are a profit from the transaction.
  • Capital losses are suffered when you sell a property at a loss.

The capital gains tax on real estate investment property is the amount that the Internal Revenue Service (IRS) will levy on a profit you generate when you sell your house, land, or business building for more than you acquired.

Short and Long-term Capital Gains Tax When Selling a House or Commercial Property

The amount of capital gains tax for selling a house or any asset will depend on how long you have owned the property before deciding to sell. The IRS will consider it short-term gains if evaluating capital gains on selling a house you have held for less than one year. If you have held the property for more than a year, the IRS will consider all the gains you make to be long-term gains.

It's vital to distinguish between the two because capital gains rates applicable to long-term and short-term profits differ. If, for example, you have houses for sale, the IRS will tax you at the same rate as any other regular income if you have held these properties for less than a year. You are eligible for reduced rates if you held them for over a year before selling.

How does Capital Gains Tax Work on Real Estate?

One of the most pressing questions for property owners is calculating capital gains tax on real estate. This question applies to any location and type of property, whether it is high-value beachfront Santa Cruz homes for sale, estates for sale in Pasatiempo, an affordable house for sale in San Lorenzo Valley, a tiny cabin for sale in Felton, or a mobile home for sale in Santa Cruz. Any property owner is keen to understand not only the amount of the tax but also the method used to determine it. Your tax rates will depend on several factors, including:

  • When you bought the property (how long you have owned it)
  • Income bracket
  • Whether it is a primary residence
  • Your marital status

Capital Gains Tax Implications for Santa Cruz Homes for Sale

The IRS will calculate your tax rate depending on your total income figure. The total income includes any capital gains. As of 2024, only capital gains are subject to the following rates (however, your other sources of income will be subject to various rates):

Single Filer Status

The IRS will not levy any taxes on capital gains on real estate if your annual income is less than $47,025. You are subject to a 15% capital gains tax rate if your yearly income is between $47,025 and $518,900. A 20% capital gains tax rate is imposed on annual incomes beyond $518,900.

Married Couple Filing Jointly

There will be no capital gains tax on selling a house if your joint earnings in that year are less than $94,050. A capital gains tax rate of 15% applies to income between $94,050 and $583,750; the rate is 20% if the joint income is more than $583,750.

Head of Household Status

Assuming you are the family breadwinner, you are exempt from paying capital gains taxes if your income is less than $63,000 in the year you file your taxes. The tax rate for capital gains is 15% on incomes between $63,000 and $551,350, and a 20% capital gains tax rate applies to incomes above $551,350.

Capital Gains Taxes on Rental Properties

The IRS applies different tax rules to rental properties regarding capital gains taxes from those applicable to primary residences. If you've previously claimed depreciation on your rental property, you may be subject to a 25% depreciation recapture tax on a portion of your capital gains. The long-term capital gains tax rates for rental properties can vary between 0%, 15%, or 20%, depending on your total earnings and filing status.

Let's consider an example: Suppose you sold a rental property you bought for $250,000 and received $50,000 in proceeds. If your gains from the sale include depreciation expenses claimed as business running expenses, the IRS will require a 25% depreciation recapture tax on that portion of the profit. Depending on your income bracket, they will assess a capital gains tax on the remaining balance at either 0%, 15%, or 20%.

The Obamacare (Affordable Care Act) and Capital Gains Taxes

Investment income (including capital gains, dividends, rentals, royalties, and interest) is subject to a 3.8% Medicare tax. However, this tax only applies if an individual's income surpasses $200,000 (for single, unmarried persons) or $250,000 (for married individuals), per the Affordable Care Act.

California Capital Gains Tax: Do not Forget Your State Taxes

Individual states also have their own criteria for levying capital gains tax on real estate. Those with Santa Cruz homes for sale must understand that California treats capital gains like any other typical income. To arrive at your taxable income, the state will add capital gains on top of anything else you file as income and levy tax on the total sum.

Over ten years, the highest income tax rate in the state remained at 13.3%. However, starting from the beginning of 2024, the new highest rate has increased significantly to 14.4%. Nevertheless, a somewhat conservative 1.1% expansion of the income tax rate was given the green light in 2023 and is already operational.

The current rate of 14.4% is based on the fact that there is no cap on the 1.1% State Disability Insurance payroll tax in California. Let’s say you have several homes in Watsonville for sale, and your earnings are above $1 million. This pushes you to a capital gains real estate tax rate of 14.4%, pushing you in the top percentile. Nevertheless, a meager tax exemption exists for capital gains, so tiny that it is difficult to categorize it as a valid exemption.

The highest federal tax rate for regular income is 37 percent. Capital gains are federally taxed at 20%. The total tax rate rises to 23.8% when you include the Affordable Care Act's 3.8% net investment tax. Thus, Californians with commercial properties or houses for sale are subject to a combined capital gains tax rate of 23.8% plus 13.3%, making it one of the highest in the world.

Can You Limit Your Capital Gains Taxes on Real Estate?

You can pursue various strategies to limit the size of capital gains tax due on your sale proceeds or avoid paying them altogether. Before we delve into some specific tactics, try these first: let's say you are venturing into Los Gatos homes for sale market. If you haven’t owned these properties for more than a year, do not be quick to sell. Stretch ownership over a year, as the IRS won’t tax your proceeds as ordinary income. Note that the Federal taxman has no ceiling for a short-term capital gain. They can hit you with up to a 37% tax rate.

1031 Exchange The 1031 exchange can help you avoid paying back the depreciation amount you had previously claimed on rental properties. It also exempts you from paying income taxes on prior depreciation deductions if you use the sale proceeds to buy another property of a greater or similar value.

Tax-Deferred Funds You do not have to use the dollars in your bank account to buy a real estate property. The Funds in your IRA (or Individual Retirement Account) or 401(K) can instead be used to achieve the same goal. Just deposit your sale profits in your retirement account and allow your money to multiply tax-free. The best part is that funds in your IRA can also qualify you for other tax deductions. Knowing your options is crucial before digging deeper into how to use 401K to buy a house. You may take out a 401(K) loan or prematurely cash out your retirement savings. But you should know there are penalties and fines for withdrawing these funds too early.

Make it Your Primary Residence. Another strategy to help avoid capital gains tax on rental property is converting it into a primary residence. What used to be known as cheap houses for sale in some prime locations in Santa Cruz just a few years ago are no longer that cheap. If your rental property for sale has spiked in value recently, move into it for at least two years to convert it into your primary residence. It can help you put a lid on your capital gains taxes.

Note that this will mean you will lose residency status on the property you are moving from (and there won’t be any exclusions on the portion that underwent depreciation while renting the property). However, it is a worthwhile move since you will regain your residency status when you sell your rental property and return to your main home. Hold on to your main home for at least two years to regain primary residency status and be eligible for capital gains exclusions later.

Tax-Loss Harvesting Consider a scenario where you're a single filer and own some cheap old houses for sale (maybe some abandoned homes for sale cheap). If selling it would result in a profit pushing your income above $47,024, you won't be exempt from capital gains tax. However, if selling the property at a loss would still leave you with more than if you had sold it at a profit and paid capital gains tax, tax-loss harvesting might be a viable option.

Invest in an Opportunity Zone Opportunity zones are areas that the 2017 Tax Cuts and Jobs Act has defined as low-income communities. Long-term Savy investors look for the cheapest land for sale, cheap houses for sale, or a cheap mobile home for sale with land in opportunity zones and get step-ups in their tax bases (their original costs). Any gains from such properties after just ten years will be exempted from taxation.

Deduct Expenses You do not have to remain with capital gains just because you sold your property at a profit. Take advantage of all tax exclusions and exemptions. Moreover, focus on any other qualifying deduction, such as:

  • Repair costs (whether on your home or rental property/commercial properties you own)
  • Property upgrades and improvements, for example, adding energy-saving additions, upgrading a kitchen or roof, etc.
  • Losses arising out of things like rent defaults by your tenants, advertising costs, professional or legal costs of evicting tenants or finding new ones
  • Closing costs Keep all documentary evidence safe and organized to support your expense deduction claims. This could include credit card statements, bills, receipts, and invoices.

Paul Burrowes, CRS, CCEC, SFR, NHCP, LHC, REALTOR® Licensed REALTOR® with over 15 years of experience and expertise. Commits to being on time and transparent. Acts as your consultant to ensure you make the best decisions to fit your transaction at every step in the process. Negotiates towards a low stress, win-win outcome. Handles all the details for you, ensuring the hundreds of steps in your real estate transaction go smoothly. Proudly serving Silicon Valley, Santa Cruz, Monterey, and Santa Clara Counties! | DRE# 01955563 | (831) 295-5130 | paul@burrowes.com | About Santa Cruz and Northern California Real Estate

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