With your children purchasing their own homes and starting their own families, you may finally decide that the time is right for you to sell your Long Island home. However, you should consider how the NYS capital gains tax could affect your sale before you proceed with any purchase.
The capital gains tax does not get discussed often. That is a big part of why it tends to catch sellers off guard.
Learning more about the capital gains tax is crucial if you want to make the best decision regarding your Long Island property. Continue with this article so you can gain a better grasp of that complex topic.
What Is the Capital Gains Tax?
The capital gains tax is a payment the government collects from individuals after they sell certain investments. They regard the investments in question as capital assets. Only the most valuable possessions are capital assets. Examples of capital assets include stocks, bonds, cars, collectibles, and real estate properties.
For this article, we will focus on the capital gains taxes that are levied on the sales of real estate properties. To find out how much you owe the government after you complete the sale of one of your properties, you need to consider the amount you paid for a property and the price you eventually sold it at.
Let’s put forth a potential scenario so we can understand the capital gains tax even better.
If you bought a home years ago for $200,000 and sold it recently for $1,000,000, the government will not take their share from that complete amount. Instead, they will only tax your gain from that particular transaction. Even then, there are still exceptions that will come into play that can lower your tax bill.
Exemptions from the Capital Gains Tax
The government grants certain exemptions from the capital gains tax. The type of exemption you get will depend on your civil status.
According to the IRS, sellers may exclude a portion of their entire capital gain from a transaction. If you are single and the capital gain from selling your home is no greater than $250,000, it excludes you from paying the capital gains tax. They will only tax your capital gain that exceeds that $250,000 threshold in that scenario.
The $250,000 threshold only applies to taxpayers who report sales as individuals. The government will exclude married couples who reap capital gains from paying the tax as long as their profit does not exceed $500,000.
Qualifying for the Capital Gains Tax Exemptions
The exemptions from the capital gains taxes probably sound appealing. They may encourage you to push through with the sale of your property. Before you make any final decisions, you need to know that not everyone is qualified for those exemptions.
The IRS requires taxpayers to pass both the ownership and the use test before they can take advantage of the exemptions we discussed previously.
If the property you recently sold was not your main place of residence, then that means you cannot pass the ownership test. In all likelihood, you will not qualify for the exemptions if you sold a home that you only inherited recently.
To pass the use test, you must prove that you were living in that home for at least two out of the five years before the date you sold it. Notably, you do not need to spend those two years consecutively inside that property. You can tally up the days you spent living in that home when you file for the exemption.
So, what are your options if you do not qualify for the exemptions based on the ownership and use tests? Well, you can check if they can grant you an exemption based on other factors.
Members of the Foreign Service, the Intelligence community, and the Uniformed Services may receive the exemption. You may also qualify for the exemptions if you were recently divorced or if your spouse passed away.
There are additional factors that could make you eligible for one of the exemptions. If you do not qualify based on the ownership and use tests, consult with a realtor or a home buying company in your area to check if you may snag an exemption differently.
Situations Where You Must Pay the Capital Gains Tax
Taking advantage of exemptions could help you avoid hefty tax payments if you recently sold your home. However, as mentioned above, we already know that exemptions do not always apply.
What are the situations where individuals must pay the capital gains tax? Let’s go through them below.
You Failed the Ownership and Use Tests
We already touched on this above, but you cannot cite any exemptions if you do not pass the ownership and use tests. Prepare for a substantial tax payment if you find yourself in that situation.
You Used the Exemption within the Last Two Years
Property owners will also be disqualified from using a capital gains tax exemption if they used it recently. To be more specific, the law dictates that property owners cannot use that exemption within a period of two years.
Make sure you keep that rule in mind when planning to sell your home. Carefully time your transactions to take full advantage of the exemptions granted to taxpayers.
You Are Obligated to Pay the Expatriation Tax
Per the IRS, citizens of the United States who have renounced their citizenship and long-term residents who ended their resident status due to tax-related reasons are obligated to pay the expatriation tax. Your expatriation tax obligations will change based on when you became an expat. In addition to the expatriation tax, you will also need to pay the capital gains tax if you sell properties you have in the United States.
What Are the Capital Gains Tax Rates in New York State?
Next up, let’s discuss the capital gains tax rates. Similar to how the exemptions work, the capital gains tax that you owe the government will change based on how long you owned the property before you sold it.
Short-Term Capital Gains Tax Rate
The short-term capital gains tax rate applies if you sold a property that you owned for less than a year. The tax rate for short-term capital gains is more variable. It will vary based on which tax bracket you fall under.
Some taxpayers may have a short-term capital gains tax rate of up to 37%. Given how onerous the short-term capital gains tax rate is, you may be well-served to hold up on selling your property.
Long-Term Capital Gains Tax Rate
Compared to the short-term capital gains tax rate, the long-term capital gains tax rate is often more affordable and predictable. The New York State capital gains tax rate for long-term properties typically settles at around 15%.
You may need to pay more than a 15% tax on your long-term capital gains based on where you live. Residents who live near New York City may pay close to 25% once they account for all factors.
How to Avoid NYS Capital Gains Tax
If you are truly looking to avoid paying capital gains tax when selling your home, the best option would be to hold the note when you sell. Holding the note is also known as seller financing, owner financing, or purchase-money mortgage. What happens, in this case, is the seller becomes the “bank.” A real estate investor or person enters a real estate agreement with the seller, but the seller holds the mortgage in their name.
Some benefits to seller financing are:
- You can receive top dollar for your home (sometimes even well over the asking price).
- You can receive monthly cash flow without worrying about property maintenance, tenants, turnovers, etc.
- You avoid NYS capital gains tax from selling outright.
- You avoid paying closing costs (the national average cost to sell a home is 10% of the purchase price when you factor in broker fees and closing costs).
- You are released from paying property taxes as this is the buyers’ responsibility now.
- The banks don’t make the money. The seller and the buyer (if they’re going to rent it out) are the only ones who will make money from this transaction.
- The terms are negotiable (i.e. down payments, interest rates, years until the balloon payment must be paid off, etc)
The main reasons why some will not seller finance:
- They do not understand the process and don’t care to learn it.
- They need a large lump sum of money for relocation or a major life event.
- They are worried the buyer will not make the payments.
- This can be easily remedied by having specific clauses in the agreement, such as no foreclosures, no evictions (as they can take years to process), after X amount of months without payment they must forfeit the home, etc.
How Can You Reduce Your Capital Gains Tax Payments?
Many property owners are hesitant to sell their homes out of fear that the capital gains tax will eat into their profits too much. Thanks to exemptions and other loopholes, you may not owe any tax payments, or it could be smaller than you thought it would be.
Of course, some property owners still need to make substantial capital gains tax payments. If you fall into that group, you may be wondering if there are things you can do to lessen your obligations.
You will be glad to know that reducing your capital gains tax payments is possible. Check out the tips detailed below and see which ones you can use to reduce your tax payments.
Offset Your Capital Gains with Capital Losses
Not all capital assets that you eventually sell are guaranteed to yield profits.
Some of them may have depreciated while you owned them. You may end up selling an asset for a price lower than what you originally paid. In that scenario, you have incurred something known as a capital loss.
Sustaining a capital loss is obviously not ideal, but it could be a useful tool for you later. If you manage to realize capital gains from the sale of a property, you can use your earlier losses to offset your tax bill. Your once hefty tax bill may look significantly lighter because of those previous losses.
Move to a Different Part of New York State
Earlier, we mentioned that you may pay additional taxes depending on which part of the state you call home. If you live in an area with an elevated tax rate, you can expect your capital gains tax to be on the high side as well.
You may not be too keen on paying a higher tax simply because of your address. In that case, moving to a different city could help you lower your taxes. Partner with a direct home buying company so you can sell your property and move to a different part of the state within a relatively short time.
Avoid Entering a Higher Tax Bracket
Income tax rates will affect your capital gains tax. New Yorkers who earn a lot of money are obligated to make substantial capital gains tax payments.
Right now, your income level may put you in a tax bracket that does not need to deal with sky-high taxes. That may change if you receive a promotion to a higher-paying position. Whatever additional income you make may be offset by your tax payments. You may be affected even more than the average taxpayer if you also have plans to sell a property sometime soon.
Time your sale to avoid entering a higher tax bracket before finalizing the transaction.
Prove That You Paid for Home Improvements
The cost basis factors into the calculation of the capital gains tax, so you want that to be accurate. The cost basis for the property you are looking to sell may be inaccurate. The cost basis may be inaccurate because you had to pay for numerous repairs shortly after originally purchasing that property.
You can point to those repairs as to why your capital gains tax should be lower. Hopefully, you have all the receipts and transaction records for those repairs on hand. They will prove useful as you attempt to reduce your tax obligations.
Use a Trust to Reduce Your Tax Obligations
Reducing your capital gains tax payments is also possible through careful estate planning. By setting up a trust, you can effectively shield your assets from different taxes.
The key here is to create the right type of trust. Work closely with an estate planning attorney and let them help you create a trust that will work best for your assets.
Utilize 1031 Exchanges
Using a 1031 exchange also gives property owners another way to avoid substantial capital gains tax payments. In 1031 exchanges, you basically swap one property for another. You can do that by using the proceeds from your sale to buy a similar property.
These exchanges can be tricky, and they are also limited in scope since they are only allowed for business and investment properties. Even so, you can defer tax payments if you can pull off this exchange properly. You may need to pay the capital gains tax eventually, but you can push that obligation farther into the future by using a 1031 exchange.
Sell your Long Island property without much issue by partnering with a direct home buying company. Reach out to us at House Buyers LI so you can move your property without getting bogged down by the often troublesome selling process.