When a homeowner sells a home or property, they are usually obligated to pay capital gains taxes after filing their taxes and entering the sales details. The typical amount of capital gains paid by the seller is either 5% or even 12% in some instances.
These taxes can put a dent in your wallet and be a headache for taxpayers everywhere after completing the sale. Because of this issue, many people wonder if they can avoid capital gains tax in Massachusetts, and if so, how?
What is Capital Gains Tax?
A capital gain tax is imposed on the sale of certain assets such as stocks and real estate. The method used to calculate a capital gain is simple. The original purchase price of the item in question is subtracted from the sale price. The remaining balance is called a capital gain.
There may not always be a capital gain on an asset’s sale, however. In some cases, the seller will incur a capital loss or when the original purchase price was more than the sale price. In this instance, the typical capital gains tax rules may change and allow for certain tax breaks. This rule is dependent on a few factors.
- The price difference
- The type of investment or asset sold
- The state the sale took place
- Who purchased the asset and who sold the asset
For situations where the asset was purchased by another individual and sold by yourself or someone other than the original buyer, you would need to consult with a tax attorney to get specific details related to your state and information on how to calculate capital gains tax for the sale, if any.
When Will You Pay Capital Gains Tax?
Capital gains tax is paid to the IRS once you file federal income tax or income tax return and the tax season is complete, and the seller has successfully filed their taxes appropriately by the deadline.
There is a time frame in which the taxes must be paid or arrangements for a satisfactory payment plan must be made with the IRS.
What is Capital Gains Tax in Massachusetts?
So you may be wondering, what is the capital gains tax in Massachusetts? According to the 2020 state government website or the U.S. federal dot gov website, Massachusetts tax rates for capital gains is 12%. Still, in some instances for different schedules, it is 5.1% and has maintained that percentage since the tax year 2016.
This is one of the highest rates in the country, and for that reason, it is worth investigating whether you can get out of having to pay that amount in taxes after the sale. According to the state’s website, capital gains listed on schedule B is 12% and includes the following assets.
- Short-term capital gains, which include collectibles.
- Long-term capital gains are outlined as installment sales before 1996.
- Property used for business or for a trade that is owned for one year or less.
Concerning the 5.1% capital gains tax rate for Massachusetts, the site lists items such as qualifying small business stock, interest on savings deposits to banks, and interest from loans from a pawnbroker.
Can You Avoid Capital Gains Tax When Selling a Home?
Perhaps you’re wondering by now if it’s possible to avoid capital gains tax when you decide to sell your home or property. There are some instances where you may be exempt, and it may depend on your marital status and the length of time you lived in the home.
Single Individuals are Exempt Conditionally
If you are single and the property you sell is sold for $250,000 or under, you don’t need to pay capital gains tax under an exemption rule. The stipulation is that you can only be exempt once in two years. You may also combine your cost basis and improvement costs to reach the $250,000.
Married Couples May Get a Break
You’re exempt from capital gains tax on sales of homes owned by a couple that sells for $500,000 and under that amount. Keep in mind that the exemption is only allowed for individuals who sell the home as their primary residence. That means you must have lived in that home for at least two of the last five years.
Remember that you may have a situation where you are still married but separated or filing taxes separately. In this instance, most states will require you to follow the rule a single individual must follow. That means you will need to pay capital gains tax on any sale over $250,000.
Factors to Consider
Although there is the rule that you must live two out of five years in the home, there is an exception that can prove to be valuable to rental property owners. Many people may decide to move somewhere else for work or temporarily, and in that instance, decide to rent out their homes to others.
Because this rule doesn’t require you to live in the home for consecutive years and allows you to convert the home into a rental property if you choose, allowing for some flexibility in those types of situations, however, you can’t sell two homes tax-free. You must wait until two years pass to be eligible for the exemption again.
Some instances where you won’t be eligible for exemption from a capital gains tax can include if the home is not the primary residence for the seller or if you sold another residence within the last two years and if the seller must pay expatriate taxes.
Another way to avoid paying capital gains tax on the sale of your home is to use a 1031 exchange. This code allows the seller to reinvest the money from the sale into another residential property. This type of exemption is also allowed for some corporations and LLCs. The rules of the 1031 exchange state that the reinvestment must occur within 45 days of the sale.
Some situations in which the capital gains tax may work slightly differently or may be calculated differently than it is in most cases. One of these instances is when the property you sell is inherited. Although the calculation is done differently, there is still the possibility you need to pay capital gains tax.
For example, if you inherit a home, the cost at the time of the owner’s death is used to calculate capital gains. For example, if you inherit a house and the value was $200,000, and you sold it a year later for $300,000, the capital gains are $100,000. The state tax percentage from the capital gains is then applied and must be paid for that year.
How to Avoid Capital Gains Tax When Selling Your MA Home
To get an exemption from capital gains tax in M.A., you can qualify for a few reasons. The first is an exemption for any capital gain of $500,00 and under this figure. This rule changes to $250,000 if you’re still married, but you file taxes separately, much like a single person would be exempt.
You may be able to get deductions for living in the home under two years out of the five-year rule, but you won’t be able to claim the entire exemption. However, the deduction could be significant. Keep in mind that you are also liable for taxes related to costs, including commissions, real estate commissions, insurance, title, and many other fees. It’s best to know your obligations and how to address them before the home’s sale.
We have gone over many instances where you would be able to avoid capital gains tax in general. These rules also apply to people selling homes in M.A. You can be eligible for $500,000 and under if you’re married and $250,000 if you single or married filing separately.
In addition, you may be able to get deductions or exemptions for renting your home for part of the two of the five-year rule. Keep in mind that in general, any capital gains you are taxed on will be at the rate of 12%, generally within a few exceptions, which are taxed at 5.1%.
Before selling your home, it’s important to know where you stand regarding capital gains tax and exemptions. If you’re unsure, it can pay to consult with an attorney or legal expert to learn what your options are and to help prepare you for the taxes imposed on the sale.
They may also be able to help you understand potential deductions and file the necessary paperwork to ensure everything goes smoothly and that you’ve complied with the law in full to avoid issues with the IRS.
Additionally, you may want to make arrangements to have the money used for capital gains put aside or paid directly after the home’s sale to ensure you can meet your obligations and avoid any issues with the government or penalties for not paying on time. Knowing your situation and having a solid plan is the best way to ensure you get the best outcome with the exemptions and deductions you’re entitled to after the sale.