Capital gains represent the difference between what investors pay for an asset (plus certain adjustments) and what they sell it for. Capital assets include real estate, stocks, bonds, collectibles, jewelry, antiques, and other items that can increase in value over time. If you don't sell the asset, any increase in its value is an unrealized gain, and won't be taxed, no matter how much the increase is.
However, if you sell the property or other asset for more than its basis, that is a capital gain. If you sell a capital asset for less than its basis, that is a capital loss. Capital losses can offset capital gains and reduce the taxes owed. If you owned the designated property for less than a year, the gain is short-term, and you would owe taxes at your ordinary income rate. That is the same rate you pay on income from wages, interest, and self-employment. It's typically higher than the rate for long-term capital gains. You must hold the asset for a year or more to qualify for the long-term rate.
States levy taxes in addition to the federal taxes
The rates for federal taxes on long-term capital gains range from zero to twenty percent, depending on income level and filing status. For example, a married couple filing jointly can earn up to $83,350 and not owe federal taxes on a realized capital gain. The rate is 15% for a couple with a taxable income of up to $517,200 and 20% for those with taxable income above that.
Nine states have no additional state capital gains tax. Some, like Texas and Florida, have no state income taxes either. Other states range from low tax states with capital gains rates around two percent up to high taxing California, which adds over 13 percent to the tab for capital gains. Aside from Texas and Florida, states with no capital gains tax are:
- New Hampshire
- South Dakota
Some states with capital gains levies allow the deduction of federal charges from state income.
Can I defer state capital gains taxes with a 1031 exchange?
Some investors prefer to defer the payment of capital gains taxes when they sell an investment property. One way to accomplish this is by executing a 1031 exchange. In most cases, a 1031 exchange will allow the taxpayer to defer both state and federal capital gains taxes, plus depreciation recapture. However, keep in mind that the rules governing exchanges are strict, and investors must closely adhere to the timelines.
Exchanges between states may have later ramifications
If you exchange property in one state for like-kind property in another, you could owe state capital gains taxes in both states when you eventually sell the replacement property. That will be the case if the original asset (relinquished property) is in a state with a clawback statute, including California, Montana, Oregon, and Massachusetts.
A clawback statute means that the state where the asset is located wants to collect the tax it would have been entitled to in the absence of the 1031 exchange. Also, Pennsylvania does not recognize the deferral, so exchanging property in that state will not defer state capital gains taxes.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Examples are hypothetical and for illustrative purposes only. Withdrawal strategies should take into account the investment objectives, financial situation and particular needs of the individual.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.