Real Estate Dictionary - Capital Gain
You probably never worried about any potential capital gain until it came time to sell your real estate property. If you listen to any of the late night finance gurus, you know that there is something ominous out there called the capital gains tax, and if you make money when you sell your property then you're going to have to pay it!
The definition of a capital gain is an increase in the value of something that you own. When something becomes worth more than it was when you bought it, you are supposed to pay tax on that extra worth. But as usual in the world of high finance, investment, and real estate, that's not the last word.
One of the most important things to remember when you're figuring your capital gain-or loss-is your basis. The basis is the amount of money that it cost you to acquire that property. But what about maintaining it? That amount is your adjusted basis. It includes the money that you spent to make it better.
Don't forget that if you make your property better, you have increased its value, and thus you are already incurring a capital gain. But you can deduct from that gain the amount of money, including the cost of supplies and your labor, for making it better.
Now let's look at some other ways to offset your capital gain. Think back to your closing. Did you pay real estate taxes that the seller owed? If so, then that amount becomes part of your adjusted basis. It is not possible to deduct this amount as part of your own taxes, but it reduces your capital gain on the property.
Many of the other closing costs are attributable to your basis. They include legal fees for the title search, fees for preparation of the sales contract and deed, any surveys done, transfer taxes, recording fees, or abstract of title fees. You can also add on the money you pay for owner's title insurance. Count in the money you pay for having utilities installed. And don't forget anything else that the seller sticks you with at the closing-any back taxes or interest. Sales commission, charges incurred by the seller for repairs and improvements, and mortgage fees all add to the basis.
You cannot include the amount you pay for fire insurance, or any rental fees for occupying the building before the closing date. Any fees charged in connection with the actual loan-loan assumption fees, appraisal, the charge for the credit report-do not figure into the adjusted basis. Some of these, however, are deductible business expenses. You cannot deduct points that you pay, but you probably can add to your adjusted basis the cost of any points paid by the seller.
You don't have to worry about paying a tax on your capital gain until you sell the property in question. And if you have used this home as your main residence for amounts of time that add up to a total of two years out of a given five year period, then you don't have to pay any capital gain. That wording is important because it means the two years that you lived in the property as your main residence do not have to be consecutive. So if you have two properties, and you divide your time between them over the course of five years, the capital gain you realize from selling them might be excludable for both properties.