Tax Law for Real Property

Purchasing property, whether it be for investment or personal use, can be a stressful experience. To add to the stress, the IRS looms over every transaction, waiting for tax time so that it can take its share. In this article, we’ll discuss the tax laws related to real property.

Real property is physical land that you own, any improvements or buildings on it, and the value of your ownership and usage rights. It is different from real estate in that real estate only includes the physical property and improvements, while real property includes the common law rights associated with the real estate.

Your Principal Residence

If you’ve purchased your own property and live there most of the time, it is considered your principal residence. You may only have one principal residence at a time. Your principal residence is subject to certain tax exclusions that other properties do not enjoy.

For instance, the sale of your principal residence is not subject to capital gains tax, provided that you lived there for at least two of the five years before its sale. However, this tax exemption is limited to $250,000, or $500,000 if married and filing jointly. This means that if your home appreciated in value beyond these limits, you will have to pay capital gains tax on the excess.

For example, if you purchased a home for $200,000 and then sold it 10 years later for $500,000, you would normally have to pay capital gains tax on the $300,000 increase in value of the home. But if this property were your principal residence, you would only have to pay capital gains on $50,000 of the increased value if you filed your taxes as single.

Investment Property

If you own more than one property, the additional properties are likely considered investment properties. This includes any properties that you rent out to others, a personal vacation home, and empty lots that you hold solely for investment purposes.

The sale of these properties is taxed under the ordinary capital gains laws. This means that if you hold the property for more than one year, then you enjoy the lower tax rate for long-term capital gains. If you sell the property after holding it for less than one year, it will be taxed like regular income.

If the property that you sell depreciates, you may claim a capital loss on that property to offset your capital gains, even if you don’t sell the property. This changes the basis of the property, or the starting value for tax purposes. This means that if you sell the property for a higher value in the future, it may be subject to additional gains. For example, if you purchase a rental property for $300,000, and the property depreciates to $250,000 in the first year, then you may claim $50,000 of capital losses to offset your capital gains. If you then sold the property for $500,000, you would have to recognize $250,000 in capital gains.

Depending on your state and local governments, all of your properties may be subject to an annual property tax. Check your state and local codes for information on these rates.

Conclusion

Taxes can be complicated, so much so that even the IRS can miscalculate how much you owe. You have a right to pay only what you owe and a right to challenge the IRS with an attorney by your side. Contact the experienced tax attorneys at Cornerstone Law Firm today, and we can help you challenge the IRS in court.