It’s tax time again…
As April 15th approaches, consider how investing in property for the long haul represents a huge benefit in the United States given the current tax code. The long term capital gains tax rate here in the U.S. favors holding onto your investment properties for at least a full year to take advantage of lower tax rates. When you look at short term vs. long term capital gains in this country, holding always makes the most sense – unless you’re trying to take advantage of a lemon of a property, and are trying to use losses on a property in the short term to your optimum tax advantage by offsetting other income with those losses.
You should remember that unless you’re specifically flipping homes, and intend to sell them within a year of purchasing them, you’ll want to take advantage of the long term capital gains tax rate, which is significantly lower than the short term rate. I will review each of these rates as regards the capital gains tax rate 2016 in detail below.
The onerous capital gains tax rate
In a recent tax policy article from taxfoundation.org (“The High Burden of State and Federal Capital Gains Tax Rates in the United States” by Kyle Pomerleau, tax foundation.org, 3/14/15), the author points out how onerous the U.S. tax code can be for short term capital gains – those investments held less than one full year. He notes that “the United States currently places a heavy tax burden on saving and investment with its capital gains tax. The U.S.’s top marginal tax rate on capital gains, combined with state rates, far exceeds the average rates faced throughout the industrialized world. Increasing taxes on capital income, as suggested in the president’s recent budget proposal, would further the bias against saving, leading to lower levels of investment and slower economic growth. Lowering taxes on capital gains would have the reverse effect, increasing investment and leading to greater economic growth.”
Negative effects of the current tax rates
In his article, Mr. Pomerleau goes on to explain the negative effects of the current capital gains tax rates on our economy, as well as the concept that capital gains taxes represent an unfair double – or triple – tax on income!. He mentions how “multiple layers of taxation encourage present consumption over saving. Suppose someone makes $1,000, and it is first taxed at 20 percent through the income tax. This person now has a choice. He can either spend it all today or save it in stocks or bonds and spend it later. If he spends it today and buys a television, he would pay a state or local sales tax. However, if he decides to save it, delaying consumption, he is subject to the multiple layers of taxation discussed previously plus the sales tax when he eventually purchases the television. This lowers the potential rate of return on an investment, which discourages saving. An individual can avoid the multiple layers of taxation on the same dollar if they spend the dollar now instead of later.
He also notes how “as more people prefer consumption today due to the tax bias against saving, there will be less capital available in the future. For investors, this represents less available capital for factories, machines, and other investment opportunities. Additionally, capital gains taxes create a lock-in effect that reduces the mobility of capital. People are less willing to realize capital gains from one investment in order to move to another when they face a tax on their returns. Funds will be slower to move to better investments, further reducing
Some basic capital gains tax tips
I have written here before with some recommendations to help investors come tax time. I have noted in past articles that there “are a few items you’ll want to discuss with your tax professional concerning your real estate investments over the last year. While you’ll have to pay taxes on profit earned from your rental properties, you may be able to limit the damage if you bought more investment property, or if you were able to move in to one of your properties and made it your primary residence prior to selling it. These are very basic investment property tax tips when selling your rental property.
Determining your profit
In order to determine your profit on a particular piece of rental property, you’ll first need to figure out your adjusted cost basis. Your purchase price is only the starting point here. You’ll then add in all your closing costs, as well as all your improvement costs to the property as well. You’ll also need to add in the total depreciation you previously claimed on the property too. Your profit is the amount you get when you subtract this adjusted cost basis from your sales basis (the selling price less costs of the sale, like broker commissions, for example.)”
How holding your property helps…
Another tip to remember is that holding onto your investment property for at least a full year makes you eligible for the long term capital gains rate. Assuming you did manage a profit when you sold your rental property in the past year, and you held the property for at least a year, you’ll pay a capital gains tax. In 2016, (and for the 2015 tax year) this tax rate continues to remain at 15%, or 20% if your taxable income as a single taxpayer is above $400,000, or $450,000 if married and filing jointly. In addition, you’ll have a surtax added to pay for Medicare – an added 3.8% of your profit if your taxable income is over $200,000, or $250,000 if married.
Will the long term capital gains rate remain unchanged?
While the current list of presidential wanna-be’s continue to duke it out on the primary trail, don’t be surprised if the capital gains rate remains at 15% through this tax year (2016). Could possible changes be coming in 2017, depending on which party takes control of the White House by January next year? Possibly, but I wouldn’t bet on it. There simply isn’t the kind of whirlwind public support for radical change in the tax code when it comes to capital gains rates – despite the bluster of a candidate like Bernie Sanders and his supporters…
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