It’s hard not to get caught up in the excitement of seeing your home equity rise like the Florida temperatures in the dog days of summer. We’ve all been pinching ourselves and teetering on the edge of giddiness. As happy as we may be about the explosion in our house values – up about 25 percent in a year – there is someone else who stands to benefit almost like a B-list guest at a Labor Day barbecue cookout. That would be our dear Uncle Sam.
“Oh, but Brian! You are wrong. Rising property tax values benefit our local governments instead of our federal government,” you may say, and you are correct. This year, this real estate boom has boosted Orange County’s tax coffers by $268 billion _ with a “B”, according to the property appraiser. But our dear, old uncle from the federal side of the family isn’t about to be left out of this buffet meal. He will get a prime cut of today’s feast – capital gains taxes.
A few weeks back, one of my clients was looking at moving to a new house while renting out his existing one, instead of selling it. He had some good reasons. Rents are at a peak now, and he can always decide to sell later, or just keep it in the family. What he hadn’t calculated, though, was the very real prospect of paying an extra 20 percent in taxes on his profits when he eventually sells this rental property.
Capital gains used to be a quiet annoyance back in the days when values edged up barely beyond the inflation rate every year. Getting a $50,000 profit on the sale of a house was cause for celebration. Reaching the capital gains threshold, which is now half a million dollars for married couples, used to seem like a distant concept. People did – and still do – think of it in the same vein as estate taxes and Medicare supplements: “Oh, right, I know I need to understand that better. Now pass over some of that brisket, please.”
But that thinking has changed now that home-sales profits are up so much. Today, buyers’ profits are often double and triple what they were just a year ago. Suddenly, this seemingly far-off notion of capital gains is much more pressing. “Why, I believe that’s Uncle Sam crashing our little pulled-pork barbecue party, isn’t he?”
For my client who was weighing the decision of whether to keep his existing house as a rental, it’s not that the threat of capital gains should prevent him from pursuing his plan. His idea may still make the most sense for him and his family. It’s just that he should be aware of the full picture before he makes a decision.
And there are certainly ways to take some of the bite out of capital gains. Any good tax attorney will tell you that you can defer capital gains using tools like 1031 Exchanges of rental properties and also tax-exempt gifts to children, which work not just for cash but also for assets.
We’ve all worked hard enough building equity and other resources. And while it’s important to give a nod to old Uncle Sam, do it in an educated way that honors your own sacrifices and financial goals. Don’t make the mistake of thinking this party is free of potential spoilers lurking at the fringe of your great moment.
Now, let’s talk about those barbecue sauces.
