Whether you are a simple homeowner or a prospective real estate investor, it is important to consider one key element of the sale of any property: taxes! Of course, the 27% capital gains tax (at top bracket) cuts directly into the profits from any savvy investments or upgrades for the investor, and any homeowner would justifiably be worried of the same thing happening to their accumulated home equity. Now, that last part is what makes what I’m about to say so valuable. Real estate has been a reasonably predictable asset class for decades now (let’s pretend ‘08 wasn’t a thing for now…), and so, holding it is usually an effective way to grow wealth. This occurs even inadvertently as you own the home.
Small tangent incoming, yet still something I find interesting. Given the massive appreciation in home values over the past few decades in the US, Canada, and most economies, many seniors, who had purchased homes in their youth are sitting on potentially millions in appreciation, and consequently have to pay incredibly high property taxes to match the updated price. This has forced many, who are unable to pay for that expense, to move out of their lifetime home in their old age, by cause of appreciation they were never planning to realize. Unfortunately, there are no tax loopholes or solutions to this, and I unfortunately can only hope that enough government condemnation over this will eventually spur action…
Bringing it back to the prime purpose of the article; when you sell your home and are faced with this capital gains tax, you’re in luck! In the US, you can be exempted from the first $250,000 of capital gains (or 500k if married filing jointly) to avoid exactly this issue. Even better, if you’re Canadian, there is no such dollar amount limitation, and you can simply ignore all capital gains taxes. For those of you who immediately realized this is a very abusable system; you would be right! However, from what I can tell, most of the holes have been plugged except for the obvious idea of simply living in an absolutely massive, and correspondingly expensive mansion to maximize the amount of money that can multiply tax-free.
So what are the restrictions applied to this:
First, the property must be and have been your primary residence throughout the time for which capital gains exemption is being claimed. That, of course, limits it only to one property at a time, and also prevents you from utilizing a vacation property (if for some reason it would be more lucrative).
You can only designate one property per year, per family (which includes spouses and children under 18)
The exemption applies to all land surrounding the property, provided it is less than one acre.
However, if you can prove that you require more than the ½ acre to use and enjoy your home, that amount can also be included in the exempt amount
Now, despite how that last one sounds, it actually is very sound and only applies to very select scenarios. For example, if your municipal zoning code has minimum surrounding property sizes, then that is meaningful proof that the extra size was a necessity. Additionally, whatever gaps left by whatever the above rules don’t cover still fall under GAAR (check out our other articles to learn more about that!), most egregious schemes would also be preventable.
I hope you guys now have a better understanding of how to keep your own home equity safe way down the road!
By: Mateo Gjinali
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