The price of real estate, like almost all other parts of the economy, is increasing. Even professional real estate auctioneers and agents cannot know the exact sale price that a piece of property may bring.
However, a little advanced homework can position a potential seller of real estate to know what taxes that person may face if that person did sell that real estate.
Initially, it is important to understand the term “basis.” Basis is essentially what the owner of a property “has in” the property. If I buy an acre of land for $1,000, my basis is $1,000. If I make improvements to that land in the amount of $100, my basis becomes $1,100. However, if I deduct $150 of improvements that are on that land, my basis decreases by $150.
In many instances, the easiest way to calculate a property’s tax basis is to use the amount that the owner of a property paid for that property.
A property’s tax basis changes when an owner of that property dies owning that property. In such an instance, the deceased owner’s basis adjusts to the fair market value of the property as of the moment of the owner’s death. The basis might go down (called a “step-down”) or might, and usually does, go up (called a “step-up”).
However, when land is gifted while the giver/owner is alive, the basis does not adjust up or down.
In other words, if my dad buys a farm for $100,000, and my dad gives me that farm two days before my dad dies but clearly while my dad was alive, my basis as the owner of the farm is $100,000.
Conversely, if I inherit my dad’s farm (that my dad paid $100,000 for) from my dad upon/after my dad’s death (through my dad’s will, trust or a transfer on death tool), the basis will adjust to the farm’s value at the moment of my dad’s death. Thus, because my dad owned the farm when my dad died, my basis as a subsequent owner will get adjusted.
The amount of gain in a real estate (capital) sale transaction is the sale price minus the basis.
Thus, if my basis is $2,000 and I later sell that land for $9,000, then my gain would be $7,000.
For sales of most people’s primary residences, the first $250,000 of gain is not taxed ($500,000 for a married couple).
Gains are generally taxed as regular income in Ohio. The federal capital gains tax rate is 0% to 20%, depending upon the size of both the taxpayer’s ordinary income and the taxpayer’s capital gains.
Some real estate sales may avoid being taxed as sales if the sellers reinvest the proceeds in other real estate. In such instances, if properly structured, the tax basis of the sold property can be transferred to the purchased property. These transactions require satisfaction of various IRS requirements by experienced and qualified professionals who are often associated or affiliated with some accounting or law firms like mine.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agriculture issues in northwest Ohio. He can be reached at [email protected] or at 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed attorney of your choice based upon the specific facts and circumstances that you face.