Tax Reporting for Real Estate Sales: What You Need to Know

Real Estate Tax Reporting Essentials: Your Comprehensive Resource

Introduction

Selling real estate can be an exciting and financially rewarding endeavor. However, amidst the stress of closing a deal, it’s essential not to overlook the tax implications that come with selling property. Understanding how property is taxed and the information needed to document the sale is crucial to ensure compliance with the law and to prevent any unexpected tax liabilities down the road. 

Property Information

Before you even think about selling your property, it’s crucial to have comprehensive records of your property. This includes the closing documents from the original purchase, which contains the purchase price, closing costs and the acquisition date.  Also, gather as much documentation for amounts of improvements and capital expenditures made to the property including fees and expenses not deducted for tax purposes during the period of ownership.   

If the property was used as a home office or other business use during the period of ownership, the accumulated depreciation taken for tax purposes on the property will have to be calculated.  The combination of purchase price, closing costs and improvements less accumulated depreciation make up your adjusted basis in the property.

Upon closing of a sale, you will receive a final closing statement that also includes the same information; purchase price, closing costs, and sale dates. The difference between the sale price less closing costs and the adjusted basis will be the capital gain or loss realized on the property. The amount realized may differ from the amount recognized. The amount recognized is the taxable gain and will be determined by how the property was used and sold.

Primary residence

If you lived in the property as your primary residence for at least two out of the last five years, you may be eligible for a capital gains exclusion of up to $250,000 (or $500,000 for married couples filing jointly).  The home sale exclusion can only be applied to capital gains, not to depreciation recapture. So, while you may be able to exclude capital gains, you’ll still be responsible for paying taxes on the depreciation recapture portion.

If you used a portion of the residence as a home office or business use and have been depreciating that portion of your property over the years, you’ve been reducing the basis of that part of your home for tax purposes. The IRS requires you to “recapture” or repay some of the depreciation you claimed as ordinary income when you sell the property. This means you’ll have to pay taxes on the amount of depreciation you claimed over the years. Depreciation recapture is typically taxed at a higher rate than the capital gains tax rate.

Investment property

If the property was not your primary residence, it’s considered an investment property, and different tax rules apply.  Primary residences can be converted to investment properties prior to sale and if the seller meets the criteria for gain exclusion described above and the gain exclusion can be applied to the sale of investment property.  

For investment property the gain realized is computed in the same way as that of a personal residence. However, in a 1031 exchange the gain recognized for tax purposes can be deferred, in whole or in part, if within 180 days of the sale of the original property you acquire one or more replacement properties using the funds held in escrow by a qualified intermediary. The calculation of recognized gain can be complicated as the debt relieved and assumed also factor into the amount recognized. The basis of the new property is the adjusted of the relinquished property plus any gain recognized. 

Conclusion

Selling real estate can be a complex financial transaction, and understanding the tax reporting requirements is essential to avoid potential issues with the IRS. Keep meticulous records of property details, sale information, and any relevant expenses. It’s also a good idea to consult with a tax professional or accountant who specializes in real estate transactions to ensure that you’re fully compliant with tax laws and regulations. By doing so, you can navigate the world of real estate sales with confidence and peace of mind.

Voss Real Estate Advisors

October 25, 2023

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