Solomon Poretsky for Demand Media writes: real estate transactions typically involve large sums of money and can significantly affect your tax deductions. This is true whether you are a buyer or a seller and whether you are transacting on a personal residence or a commercial property. Real estate transactions usually have two effects on your taxes -- they can change how many deductions you are able to claim in a given year and they might also generate additional taxes that are directly tied to the transaction.
PREPARING TO BUY A HOUSE
Buying a home typically changes your taxable income. If you aren't currently a homeowner, the ability to write off your mortgage interest and property taxes once you buy your home might provide the chance for a bigger overall tax break by itemizing your deductions instead of claiming the standard deduction. If this is the case, familiarize yourself with the Schedule A form to check for other purchases that will be deductible. If you're already filing Schedule A, your deductions will change with the new mortgage and property tax amount.
PREPARING FOR THE SALE OF YOUR HOUSE
Selling your house brings two tax issues. If you will not be buying another house and will instead be renting, you will lose any deductions that you had been claiming for your mortgage interest expense and for the property taxes you pay. This could increase your tax liability, so you might want to talk to your employer to have them adjust your withholding.
The second issue that could come up is if you have a significant profit on the sale of your home. If you are single you can collect up to $250,000 in profit tax free from the sale of a home, and if you are married, filing taxes jointly, you up to $500,000 in tax-free capital gains, as of publication. To find out your liability, calculate your cost basis, which is what you paid for your house, plus your closing costs plus the cost of any major improvements you made to your house. Subtract that from your net selling price after subtracting commissions and fees. If you will have a profit above those thresholds, you will either need to set aside money to pay capital gains taxes or sell other assets for loss in the year of the sale.
HOME OFFICES
If you had a home office in a house that you sold, you could be subject to an additional tax -- the Section 1250 depreciation recapture tax. When you have a home office, the IRS requires you to depreciate it. Depreciation is a way of simulating the gradual deterioration of business property, and home offices are treated as commercial real estate that has a 39-year life. For example, if you have a $200,000 house and 11 percent of it is in your designated home office, you'd be able to claim $564 in depreciation every year, which is 1/39th of the $22,000 value of the home office.
When you sell your house, you calculate your depreciated cost basis by subtracting all of the depreciation that you claimed, or could have claimed even if you didn't, from your cost basis. You then pay 25 percent depreciation recapture tax on all of the depreciation that you claimed that you got bay at the sale. If you had your home office for nine years, you'd have to pay the 25 percent tax on the $5,076 in accumulated depreciation you claimed.
INVESTMENT PROPERTIES
Investment properties typically do not have a major impact on your taxes when you buy them. If they are profitable, you will have to report the income and pay taxes on it, though. When you sell them, though, you should be prepared to pay a great deal of tax. All of your profits from selling the property are subject to capital gains tax and all of the depreciation that you claimed is subject to the 25 percent depreciation recapture tax. However, if you intend to use the proceeds from the sale to buy more investment property, you can structure the sale as a tax-deferred exchange, also known as a 1031 exchange. If you do this, you can carry your cost basis forward into the new property and defer paying your capital gains and depreciation recapture taxes until you sell your replacement property. You can also exchange your replacement property into another new property and continue carrying your basis forward.
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