Many homeowners across the country have seen their home values increase in recent years. According to the National Association of Realtors, the median price of existing homes sold in July of 2023 rose 1.9% over July of 2022 after a couple of years of much higher increases. The median home price was $467,500 in the Northeast, $304,600 in the Midwest, $366,200 in the South and $610,500 in the West.

Be aware of the tax implications if you’re selling your home or you sold one in 2023. You may owe capital gains tax and net investment income tax (NIIT).

You can exclude a large chunk

If you’re selling your principal residence, and meet certain requirements, you can exclude from tax up to $250,000 ($500,000 for joint filers) of gain.

To qualify for the exclusion, you must meet these tests:

1. You must have owned the property for at least two years during the five-year period ending on the sale date.
2. You must have used the property as a principal residence for at least two years during the five-year period. (Periods of ownership and use don’t need to overlap.)

In addition, you can’t use the exclusion more than once every two years.

The gain above the exclusion amount

What if you have more than $250,000/$500,000 of profit? Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, provided you owned the home for at least a year. If you didn’t, the gain will be considered short-term and subject to your ordinary-income rate, which could be more than double your long-term rate.

If you’re selling a second home (such as a vacation home), it isn’t eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 like-kind exchange. In addition, you may be able to deduct a loss, which you can’t do on a principal residence.

The NIIT may be due for some taxpayers

How does the 3.8% NIIT apply to home sales? If you sell your main home, and you qualify to exclude up to $250,000/$500,000 of gain, the excluded gain isn’t subject to the NIIT.

However, gain that exceeds the exclusion limit is subject to the tax if your adjusted gross income is over a certain amount. Gain from the sale of a vacation home or other second residence, which doesn’t qualify for the exclusion, is also subject to the NIIT.

The NIIT applies only if your modified adjusted gross income (MAGI) exceeds: $250,000 for married taxpayers filing jointly and surviving spouses; $125,000 for married taxpayers filing separately; and $200,000 for unmarried taxpayers and heads of household.

Two other tax considerations

• Keep track of your basis. To support an accurate tax basis, be sure to maintain complete records, including information about your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed for business use.
• You can’t deduct a loss. If you sell your principal residence at a loss, it generally isn’t deductible. But if a portion of your home is rented out or used exclusively for business, the loss attributable to that part may be deductible.

As you can see, depending on your home sale profit and your income, some or all of the gain may be tax-free. But for higher-income people with pricey homes, there may be a tax bill. We can help you plan ahead to minimize taxes and answer any questions you have about home sales.

© 2023

Let’s say you own highly appreciated land that’s now ripe for development. If you subdivide it, develop the resulting parcels, and sell them off for a hefty profit, it could trigger a large tax bill.

In this scenario, the tax rules generally treat you as a real estate dealer. That means your entire profit — including the portion from pre-development appreciation in the value of the land — will be treated as high-taxed ordinary income subject to a federal rate of up to 37%. You may also owe the 3.8% net investment income tax (NIIT) for a combined federal rate of up to 40.8%. And you may owe state income tax too.

It would be better if you could arrange to pay lower long-term capital gain (LTCG) tax rates on at least part of the profit. The current maximum federal income tax rate on LTCGs is 20% or 23.8% if you owe the NIIT.

Potential tax-saving solution

Thankfully, there’s a strategy that allows favorable LTCG tax treatment for all pre-development appreciation in the land value. You must have held the land for more than one year for investment (as opposed to holding it as a real estate dealer).

The portion of your profit attributable to subsequent subdividing, development, and marketing activities will still be considered high-taxed ordinary income, because you’ll be considered a real estate dealer for that part of the process.

But if you can manage to pay a 20% or 23.8% federal income tax rate on a big chunk of your profit (the pre-development appreciation part), that’s something to celebrate.

Three-step strategy

Here’s the three-step strategy that could result in paying a smaller tax bill on your real estate development profits.

1. Establish an S corporation

If you individually own the appreciated land, you can establish an S corporation owned solely by you to function as the developer. If you own the land via a partnership, or via an LLC treated as a partnership for federal tax purposes, you and the other partners (LLC members) can form the S corp and receive corporate stock in proportion to your percentage partnership (LLC) interests.

 

2. Sell the land to the S corp

 

Sell the appreciated land to the S corp for a price equal to the land’s pre-development fair market value. If necessary, you can arrange a sale that involves only a little cash and a big installment note the S corp owes you. The business will pay off the note with cash generated by selling off parcels after development. The sale to the S corp will trigger an LTCG eligible for the 20% or 23.8% rate as long as you held the land for investment and owned it for over one year.

3. Develop the property and sell it off

The S corp will subdivide and develop the property, market it, and sell it off. The profit from these activities will be higher-taxed ordinary income passed through to you as an S corp shareholder. If the profit is big, you’ll probably pay the maximum 37% federal rate (or 40.8% percent with the NIIT. However, the average tax rate on your total profit will be much lower, because a big part will be lower-taxed LTCG from pre-development appreciation.

Favorable treatment

Thanks to the tax treatment created by this S corp developer strategy, you can lock in favorable treatment for the land’s pre-development appreciation. That’s a huge tax-saving advantage if the land has gone up in value. Consult with us if you have questions or want more information.

© 2023

An estimated 190 million Americans have recently been under heat advisory alerts, according to the National Weather Service. That may have spurred you to think about making your home more energy efficient — and there’s a cool tax break that may apply. Thanks to the Inflation Reduction Act of 2022, you may be able to benefit from an enhanced residential energy tax credit to help defray the cost.

Eligibility rules

If you make eligible energy-efficient improvements to your home on or after January 1, 2023, you may qualify for a tax credit of up to $3,200. You can claim the credit for improvements made through 2032.

The credit equals 30% of certain qualified expenses for energy improvements to a home located in the United States, including:

1. Qualified energy-efficient improvements installed during the year,
2. Residential “energy property” expenses, and
3. Home energy audits.

There are limits on the allowable annual credit and on the amount of credit for certain types of expenses.
The maximum credit you can claim each year is:

1. $1,200 for energy property costs and certain energy-efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600 total), and home energy audits ($150), as well as
2. $2,000 per year for qualified heat pumps, biomass stoves, or biomass boilers.

In addition to windows and doors, other energy property includes central air conditioners and hot water heaters.

Before the 2022 law was enacted, there was a $500 lifetime credit limit. Now, the credit has no lifetime dollar limit. You can claim the maximum annual amount every year that you make eligible improvements until 2033. For example, you can make some improvements this year and take a $1,200 credit for 2023 — and then make more improvements next year and claim another $1,200 credit for 2024.

The credit is claimed in the year in which the installation is completed.

Other limits and rules

In general, the credit is available for your main home, although certain improvements made to second homes may qualify. If a property is used exclusively for business, you can’t claim the credit. If your home is used partly for business, the credit amount varies. For business use up to 20%, you can claim a full credit. But if you use more than 20% of your home for business, you only get a partial credit.

Although the credit is available for certain water heating equipment, you can’t claim it for equipment that’s used to heat a swimming pool or hot tub.
The credit is nonrefundable. That means you can’t get back more on the credit than you owe in taxes. You can’t apply any excess credit to future tax years. However, there’s no phaseout based on your income, so even high-income taxpayers can claim the credit.

Collecting green for going green

Contact us if you have questions about making energy-efficient improvements or purchasing energy-saving property for your home. The Inflation Reduction Act may have other tax breaks you can benefit from for making clean energy purchases, such as installing solar panels. We can help ensure you get the maximum tax savings for your expenditures. Stay cool!

© 2023