Capital Gains Tax on Estate you need to know before you sell that real estate
- Do you wonder why capital gains is important to your estate plan? Well, by the end of today's video, you'll have a better idea. The dictionary's definition of a capital gains tax is a tax levied on profit from the sale of property or an investment. Sounds pretty simple, right?
In our last three videos, we discussed the 2021 federal estate tax exemption, President Biden's proposal for estates, and President Biden's proposed changes to the stepped up basis. The reason we're spending so much time on this is because as the estate tax laws stand right now, they only affect a really, a very, very small percentage of United States taxpayers as far as owing estate tax.
However, if changes are made to the stepped up basis, then everyday Americans might have to start paying a capital gains tax. To learn more about what stepped up basis means, go back and watch this video up here after you finish this one, of course. Today let's first talk about some important points.
Capital gains tax is a federal tax on the profit from selling certain assets such as stock, investments, bonds, jewelry, coin collections, and of course, real estate. Collectively, these are all sometimes referred to as capital assets. The IRS taxes capital gains differently depending on whether they are long-term or they're short-term, and the capital gains tax is only paid on the profit or the realized gained after an asset is sold.
People sometimes think they owe a tax just because their house or stock has increased in value, but the tax is only paid after an asset is actually sold. That's an important point to remember. It's also important to remember that capital gains can be offset by capital losses. Long-term capital gains for assets held longer than a year are taxed at either 0%, 15% or 20% depending on your tax bracket. Short-term capital gains for assets held less than a year are taxed as ordinary income. So all you day traders out there, you need to be careful.
There are some special rates for certain types of assets, such as collectibles, which are actually taxed at 28% regardless of your income, so you need to check with your CPA or your tax professional when you sell any of those types of assets, collectibles. The biggest asset that most people have when it comes to their estate plan is their home, right? I think you'd agree with me on that.
So let's look specifically at what capital gains means to your home, and really, later on to your estate plan. Individuals must pay capital gains on any profit over $250,000 when they sell their personal home. The home that they're actually living in. Married couples must pay capital gains on any profit over $500,000. It's again, important to remember, these numbers are for owner occupied homes, homes that you actually are living in. Investment real estate has its own set of rules, and well, that's for another video.
Let's look at an example of a married couple who purchased their home in 1975 for $25,000. I've seen it. If they sell their home this year, 46 years later, for $825,000, then they've made a profit of $800,000, right? But remember, a married couple pays a capital gains tax on the amount of profit over $500,000. $800,000 minus 500,000 equals and means they owe a capital gains tax on $300,000, then depending on their tax bracket, they will have to pay capital gains of either 0%, 15% or 20.
Now this is a very simple example of capital gains tax regarding owner owned real estate. What is important for estate planning is how this relates to the stepped up basis which is the law of the land right now. Like I said, I did a video on stepped up basis, but basically, stepped up basis means that your heirs inherit your property at its value on the day of your death. You see how important this is to estate planning how that we've talked about capital gains.
Let's go back to our earlier example. This time, let's say the husband dies first, leaving his wife as a widow. While she is still living, the wife decides to sell or give the marital property, the home, to their son, Enrique. On the day of this transfer, the house is worth $825,000, just like before. By doing so, the wife has just triggered a capital gains tax on $800,000.
However, if instead, Enrique inherits the house, when his mother dies, then he inherits it at the stepped up basis or the value on the date of her death, and no capital gains tax is due. Enrique inherits a stepped up basis of $825,000, which was the value of the house on the date of his mother's death.
If Enrique decides to sell the house, let's say two years later, for $925,000, then he would owe a capital gains tax on $100,000, which is the difference between what he sold it at, 925,000, and the stepped up basis he inherited the house for at 825,000.
In doing probates for over 20 years, I have seen hundreds of estates, just like in the example above, where a couple bought their marital home 30 or 40 years ago and stayed in it until both of their deaths. That is why the stepped up basis is so important. I can tell you that if Congress messes with a stepped up basis, and therefore, the capital gains tax, then a lot of United States taxpayers are going to be in for a very big and rude surprise.
We will have to see what, if anything, Congress decides to do on this issue. Stay tuned. I know I've thrown a lot at you today, so that's why we've prepared our free guide on estate planning. I'll put a link to it in the description below and in the comment section below that so that you can download it and get started in the right direction, and to help you out even more, watch this video up here and this video up here. If you enjoyed this video, then guys, please smash that subscribe button and click on the like button, and also, click on that little bell so you'll get notified every time we post a new video. Have a great day and an awesome week, and as always, thanks for watching.