A number of tax laws may apply to a real estate transaction. This isn’t surprising, considering that a real estate purchase is the single biggest transaction most people will ever complete. In fact, real estate represents the main source of wealth for most citizens because it can be highly profitable. For that reason, various taxes can all apply to a real estate transaction.
In this guide, we’ll go through all of the potential tax burdens your transaction may entail, and explain if and when you may be responsible for paying them.
If you’re curious about the tax on a real estate transaction itself, there isn’t one in the United States. However, if you live in the United Kingdom, your purchases will be subject to a transaction tax.
If you live in the UK, your real estate transactions will be subject to a real estate transaction tax. According to KPMG Global, “On 1 October 2020, Royal Decree A84 was issued announcing the creation of a new Real Estate Transaction Tax (RETT) with a rate of 5% calculated on the value of the real estate transaction.”
At the same time RETT was introduced, real estate transactions in the UK became exempt from Value Added Tax (VAT).
Back in 2012, multiple sources announced that “all real estate transactions will be subject to a 3.8% federal sales tax” as of January 2013. These baseless claims became so widespread that the Journal of Accountancy and the National Association of Realtors both had to step in to put taxpayers’ minds at ease.
While buying or selling real estate will make you responsible for certain local, state, and federal taxes, no law actually taxes the transaction itself in the way that sales tax would tax your purchase at the local store.
Real estate taxes in the United States are divided up into many categories and they vary from one jurisdiction to the next. For instance, your state may have its own real estate taxes to impose, but so may your local city or county. Here’s an overview of all the taxes you may be responsible for.
Once you purchase your home, or if you already own a home, you’re responsible for paying property taxes, also known as “real estate taxes.” Property tax is collected by your local government based on an annual tax assessment of your property. You’ll pay these taxes each month as part of your mortgage payment.
Once your mortgage is paid off, you’ll pay property taxes annually to your local tax assessor. You will continue to pay property taxes for as long as you own the property, although the amount you pay will vary as your home’s tax accessed value changes each year.
When you sell your home, you may be subject to capital gains tax. This tax applies if the amount you sell your home for is greater than its “cost basis,” which is the sum of:
- How much you paid for the property when you purchased it.
- The cost associated with the purchase (i.e., mortgage application fee, cost of home inspection, appraisal fees, etc.).
- The cost of major improvements you’ve made since the purchase (i.e., new roof, extensions, etc.).
The capital gains tax you pay, if any, will be calculated only on your profit (i.e., your “gain”) rather than the net proceeds or sale price. So, to calculate your gain, deduct the cost basis from your net proceeds. If the number if negative, you haven’t exceeded the cost basis and aren’t subject to capital gains tax. If the number is positive, you may owe capital gains tax.
For most homeowners, they can deduct up to $250,000 if single or up to $500,000 if married and filing jointly from the capital gains of their primary home’s sale. However, to do so, the home has to be your primary residence, you have to occupy the property for at least two out of the last five years (consecutive or nonconsecutive), and you must have owned the house for at least two of the last five years.
Other capital gains tax exclusions may apply if you’ve sold your home: to relocate for a job; because of medical reasons; or due to unforeseen circumstance, like a natural disaster or divorce that led to you being unable to afford your home.
If you purchase and own property as an investor, you may be subject to more than just the property taxes associated with owning property. Investors can also be subject to real estate income taxes. Real estate income is anything you earn from renting out your property, minus any deductible expenses. Rental income is taxed at the same rate as your other income.
When you sell your property, you’ll be subject to capital gains tax just like any other home seller. However, investors can often take advantage of additional exclusions, so it’s a good idea to speak with a tax advisor.
When purchasing a home, your state may subject you to a real estate transfer tax. Some states do not have a transfer tax at all, but if yours does, it will be due at the time of closing and factored into the closing costs. Since most buyers end up splitting the closing costs 50/50 with the seller of the home (or even requesting the seller to pay 100% closing costs), you won’t necessarily have to pay the full amount of the transfer tax.
Unlike some taxes, you cannot deduct the amount you pay in real estate transfer taxes when filing your income taxes. However, when you go to sell your home down the road, you can add the real estate transfer tax you paid to your cost basis, thereby reducing the amount of capital gains tax you may owe.
Calculating your tax burden can be complicated, especially since state and local tax laws can vary and have multiple exclusions or exceptions. Your best bet is to speak to a trusted tax professional if you have any questions, but when it comes time to actually finalize your next real estate transaction, make sure you rely on the right tools.
Here at LemonBrew, we know that real estate transactions are complicated, and we’re dedicated to simplifying the process. If you’re just starting your journey, we can match with a local real estate agent who can take you through every step. We also offer a variety of other tools, including our mortgage services, to make the buying journey stress-free and fun. By working with LemonBrew, you’ll enjoy expert guidance throughout every step of your journey. Get started today!