Every week, Mansion Global poses a tax question to real estate tax attorneys. Here is this week’s question.
I'm looking into flipping a few properties this year in the U.S., and I'm relatively inexperienced. What are the tax impacts of quickly buying and then selling a property? Is it better to wait longer before I resell?
Capital gains and real property taxes are the two main taxes involved with real estate transactions in the U.S., said H. Michael Soroy, principal at Law Offices of H. Michael Soroy, in Los Angeles.
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Real property taxes are based on the property’s market value at the time it is purchased. A federal capital gains tax, meanwhile,is levied on the net profit at the time of sale. How long the property is held before it is resold usually determines the amount of the tax.
"In general terms, property held for investment less than 12 months will be taxed as a ‘short-term’ capital gain," said Edward J. Hannon, partner at Quarles & Brady law firm in Chicago. "The rate on short-term capital gain is the same rate that applies to ordinary income (i.e., regular tax rates)."
In addition, 41 states have their own capital gains tax on real property sales, "typically levying 3% to 8% on the net gain," Mr. Soroy noted.
When property held for more than 12 months is sold, the gain arising from the sale will be taxed at the "long-term" capital gains rates, which are subject to a reduced rate compared with the short-term rate, Mr. Hannon said.
"For example, a taxpayer in the top marginal rate will be subject to federal income tax at the 39.6% rate on short-term capital gains, but the rate applicable to long-term capital gains would be only 20%," he explained.
Sometimes it does make a difference whether a property is held for 12 months and in some cases, It’s not always financially better to hold a property for 12 months before selling. Such instances, Mr. Soroy noted, include:
If the seller is a foreign national, who’s neither a U.S. citizen nor a U.S. resident. "The federal capital gains tax rate is a flat 30% for nonresident aliens and does not take into account long-term versus short-term or individual tax brackets," Mr. Soroy said. "Thus, a nonresident alien’s (foreign national’s) decision to sell or not within a year should not be solely governed by the federal capital gains tax rate." But any state capital gains tax would still apply.
If the seller is a U.S. resident in a lower-income tax bracket. A lower bracket will result in lower capital gain taxes. "If the flipper resides in the U.S., the difference can be as high as 20% between long-term and short-term–typically around 10% to 15% depending on the flipper’s income tax bracket." If there are "plausible signs that the market is about to peak or flatten," Mr. Soroy said. "It’d be better to "take a hit on the capital gains tax rate in a depreciating market instead of a loss after the 12-month period."
And there are what’s called "like-kind exchanges."
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"In certain circumstances, a taxpayer can engage in a like-kind exchange which, in effect, allows a property owner to sell one property tax-free if the taxpayer acquires a replacement property and meets the many conditions set forth in Section 1031 of the Internal Revenue Code," Mr. Hannon said.
"There is no minimum holding period to be eligible for like-kind exchange treatment. However, the taxpayer must be able to establish that the relinquished property was held for investment," he said.
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