Investment Property Jargon Explained - Capital Gains Tax

The second in our series of articles about investment property jargon looks at capital gains tax.

If you successfully make money through buying and selling an investment property you'll want to hold on to as much of that profit as possible. So a thorough understanding of capital gains tax is essential.

The concept of capital gains tax is much the same in any country or market, it is a way for the local fiscal authorities to raise cash from the profit made by investors in real estate, as well as other asset groups.

The gain in capital you make on your investment property is essentially the difference between the price you paid and the price you sell it at. In other words: the profit.

Usually, capital gains tax is calculated as a simple percentage of this profit, but it may be possible to deduct other expenses from the gain, which will bring the amount down, and with it, the tax you pay.

In some areas the rate of inflation will be taken into account too, allowing you to calculate the "real" gain in capital relative to the economy as a whole.

As with most tax laws, people have always sought loopholes or ways to avoid paying it. In less scrupulous markets it's possible that the reported sale price of some investment property is lower than the true amount, thus reducing the investor's tax burden.

In countries where the sector is poorly regulated or policed, it's possible that a large part of the purchase price is paid "under the table" in cash, so the reported transaction price is lower than the real amount.

In its simplest form, the equation to calculate capital gains tax on investment property is:

(Sell Price - Buy Price - Deductible Expenses) x Capital Gain Tax Percentage Rate.

Since capital gains tax regimes can vary significantly between different countries and property markets, it is well worth seeking out an experienced adviser, such as an accountant, notary or lawyer, who can guide you through the different solutions.

If possible, find someone that is familiar with investment property in particular, since the rules for taxing real estate may be different to those for other types of assets with gains in capital.

The money they save you could pay for their services many times over in some cases, so it is well worth seeking their advice. For example, they may have tips on how to structure your deal so you can maximize the deductible expenses that you can subtract, or find a way of charging a lower tax rate on your capital gain.

Either way it's very simple: the more you can save on capital gains tax the more you can make on the sale of your investment property.

Capital Gains Tax Explained - CGT UK Checklist and How To Pay CGT

Capital Gains Tax ( CGT)

What is CGT?

It is a tax imposed by the government on individuals who make a gain by selling assets other than their main home, such as making a profit on stocks or profiting from properties which are bought for the purpose of resale.

Why is it important to know about CGT?

You may end up receiving a hefty bill on your personal earnings as each year the CGT tax alone contributes arround 3 billion pounds a year to HM Revenue and customs.
Who is liable to Pay CGT

All UK residents are subject to CGT if they make a gain over the given limit.

Whats the CGT exemption limit?

In the last 10 years CGT allowance has risen from just 6500 to 9200, which means anything earned outside the 9200 bracket will be held liable for CGT.

Secondly exemption applies on assets such as your

* Personal home

* Premium Bonds

* Stocks and shares held in ISAs or PEPs

* Child Trust Funds

* National Savings Certificates

* Personal Cars and posessions worth upto 6000

* Also in the event of death the assets belonging to a person are not liable to CGT

When is CGT Paid?

This is payable on 31st January following the end of the tax year in which the gain has been made.

Any Concessions under CGT?

Taper Relief policy has been made available to precisely calculate and reduce the amount of CGT by assessing the duration the asset has been kept.
How to pay GCT?

All gains made over the set government limit must be reported to HM Revenue & Customs.
For further help and guidance hmrc.gov.uk has detailed information and reliefs available on CGT.

Capital Gains Tax Laws Explained

Would you like to know what is considered capital gains by the IRS? Would you like to know how much it might cost you?

Capital gains is what the IRS says is your profit when you sell something that is defined as a capital asset. Real estate, mutual fund shares, stocks, and bonds are all considered capital assets. If you inherited a home or real estate you might be subject to the capital gains tax.

How Much is The Capital Gains Tax Rate?

Your tax will depend on a few things. If you have a short term capital gain you will be taxed at your normal tax rate. However, if you have a long term gain you will be taxed at 15%. If you are in a tax bracket of 14% or less you'll be taxed at 5%.

How do I know if I have a short term or long term gain? To determine whether you have a long or short term capital gain is quite simple. Property that you own for less than one year is defined as short term. Property that you own for more than one year is defined as long term.

What if I lost money?

If you lost money on a capital asset it can be deducted on your taxes. Money that you lost on an investment is used first against profits you've made on another investment. Short term and long term capital losses can both be deducted but there are certain rules for each type of capital gain.

Take the Cash and Run - The 351 Exchange Explained

Many real estate investors have heard of the 1031 exchange, a technique where property held for investment is exchanged for "like kind" property thereby deferring capitol gains taxes until a later tax year. While investors like being able to defer taxes until a later year, many complain that they'd like a way of eliminating capital gains taxes altogether. Another major gripe of 1031'ers is that the proceeds of the transaction must be used to immediately acquire a replacement property. Failing to find a suitable property causes the entire deal to fail and leaves the investor saddled with a large tax bill. Not cool. The solution: an alternate technique, called the 351 exchange. This method allows for both, tax deferral and flexibility to use the transaction proceeds as the investor sees fit.

Here's how it works:
The 351 exchange allows the investor to defer, and maybe eliminate, the capital gains liability on the sale of real estate by exchanging title to the property for stock in a c-corporation created specifically to acquire real estate for resale purposes. No Capital gains taxes are recognized when the real estate passes to the c-corp and the c-corp pays ordinary income, not capital gains, taxes when the property is eventually sold. What's more, the proceeds from the sale do not necessarily need to be reinvested in more real estate. Unlike a 1031 exchange, the cash resulting when the c-corp eventually sells the real estate can be spent on anything that could be classified as "ordinary and necessary" for the operation of a real estate business. Cool trick huh? Lets take a look under the hood.

Here's why it works:
The property is permitted to pass from the investor free of capital gains taxes due to Section 351 of the Internal Revenue Code. It provides that "No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control [at least 80% ownership] of the corporation."

The explanation of how, and why, the c-corp can sell the property free of capital gains tax is a bit more involved. Generally, you will have a capital gain or loss if you sell or exchange a capital asset. Almost everything you own and use for personal purposes or investment is a capital asset except that property held mainly for resale is not considered a capital asset. IRS Publication 538 tells us that "Stock in trade, inventory, and other property you hold mainly for sale in your trade or business are not capital assets." The c-corp that you will use to dispose of property in a 351 exchange, was created especially for the purpose of buying real estate for resale meaning that the property is treated as inventory rather than a capital asset. A good understanding of this concept of inventory v. capital asset is key to appreciating the benefit of the 351 exchange. Here are some examples:

• Apartment bldg. rented for income- Capital Asset
• Homes owned by a builder for sale to the public- Inventory
• Merchandise held by a retailer for eventual resale- Inventory
• House owned by a flipper for rehab & resale- Capital Asset
• Office bldg. owned by a doctor to house his practice- Capital Asset

What about taxation on the sale of inventory?
I'm glad you asked. Unlike individuals who generally receive income, pay taxes, then pay expenses out of the difference; a corporation earns revenue, deducts expenses, and pays taxes on whatever is left. The name of the game is to have as little left over as possible. The c-corp has the benefit of several well known and perfectly legal methods of handling expenses that are not available to individuals or to other types of business entities. These include things like employee benefit/compensation plans (where you are the employee of course), vehicles, and health insurance, retirement plans, rental of office space plus the accompanying expenses such as utilities and supplies, and of course, to purchase more real estate (for resale), which will also be classified as inventory, not a capital asset

Aren't C-Corporations subject to double taxation?
Therein lies the rub...or so it appears. The subject of double taxation is seen by many planners and advisors as the main drawback with using the c-corp. Double taxation comes into play where after-tax earnings of a C-Corporation are distributed to shareholders as non-deductible dividends. While this is a valid concern in theory, in practice, it really should not trouble most small corporations with earnings under $5 million because of the many deductible ways to pull money out of a c-corp and avoid double taxation such as:

• Employee Compensation Plans
• Interest Payments (including loans you might make to your entity)
• Lease Payments (includes vehicles, equipment, airplanes and real estate)
• Retirement Plans (for you and your family)
• Benefit Plans (including Life and Health Insurance)
• Non-Taxable Reimbursements to you for personal funds you expended on behalf of your C-corporation.

It's not all upside though
By now you're probably saying, "What's the catch?" The catch is that the 351 exchange is not right for everyone. Many of us believe that real estate investments are long term commitments, like a marriage, as opposed to trades in the stock market which tend to be short term in nature, like taking home someone you just met at a night club (exciting but often risky and usually short-lived). If you fall into the long-term category, you're likely looking to trade-up in real estate rather than cash-out. In this case, a 1031 exchange might be more your flavor. The other issue is the cost and somewhat complex process of starting and maintaining the corporation.

While the cost and procedure of setting up a c-corp are not that onerous, there is a bit of formality. Establishing a c-corp will require the filing of certain documents with the State and complying with a few legalities. There will be attorney's fees involved in getting it off the ground as well as annual fees to maintain compliance. Because of the cost, the 351 exchange is probably better for the larger real estate investors as opposed to the guy that rents out a couple houses.

Final synopsis
In the end the 351 exchange might be a great option for investors looking to cash out and use the proceeds for something other than immediately buying another property. But don't take my word for it. All of you real estate moguls, and moguls to be, should consult with a competent real estate/tax attorney before committing to any transaction.

Capital Gains Tax Explained

The Capital Gains Tax which is typically also known as CGT is basically charged on the profits that you make over the annual allowance. This means that any gain that you make over the allowance has to be paid for in the form of Capital Gains Tax.

The payment of CGT is different for different people, and also differs in case of the situations that apply. Basically, the amount that you pay for the tax is dependent upon the asset from which you had the capital gain and the time period for which you have been holding the asset before you had the gain.

The tax rules that apply on the capital gains tax differ for the business assets and non-business assets. A rule that was applied in 1998 was about the holding period of the asset and the tax on the capital gain. According to the rule, the longer an asset is held for, the lesser is the tax that has to be paid over the gains from that asset.

Some of the situations that are counted as you having capital gain or loss are the giving away of the asset to someone, your owned asset being destroyed or lost, and several others. In general circumstances, the most common situation which requires you to pay the Capital Gains Tax is when you sell something and you get more amount for it than what you had paid. Giving something away or getting compensation money also entitles you to paying the CGT.

There are also some exceptions that apply to the Capital Gains tax, and if any of those situations occur, you would not be entitled to pay CGT. One of these situations is when you are selling or just passing away belongings, the worth of which is less than six thousand pounds. Giving away the items to a registered charity is also an exception and in this case you don't have to pay the tax.

Another exception to the payment of the CGT is that, if you are selling your privately owned car or selling your primary home, you are not required to pay the Capital Gains Tax. The tax also does not apply to the payments received from premium bonds, personal injury compensation, and lottery winnings.

There are different rates of the Capital Gains Tax that apply for different income levels. Any asset which is your personal principle asset does not require you to pay GCT on it. However, all the investment properties are subject to tax. When paying the Capital Gains Tax, it is important to remember that whatever amount of capital gain you receive gets added to your taxable income before the marginal tax rate can be applied on it.

When you are calculating the amount of the Capital Gains Tax, it is important to remember that the date of sale or acquisition of the asset that is considered is the one mentioned on the purchase/sale contract. The assets on which a discount can be received are those that are in the name of an individual, and there is a specific time period for which it should be owned.

Stock Option Plans, Statutory & Non-Statutory Explained

Statutory Stock Option Plans.

Generally, property transferred to an employee in connection with services performed by the employee, results in ordinary income to the employee and a deduction to the employer. The Code does provide for special tax treatment for statutory stock options. The transfer of a statutory stock option to an employee has no tax consequence until the employee sells the stock. At that time, the employee pays capital gains tax (generally 15%) on the difference between the option price and the amount received. However, if the option price was less than the fair market value at the time the option was granted, the employee must recognize ordinary income (taxed up to 35%) on the difference between the option price and the fair market value at the time the option was granted.

As this is extremely confusing, an example is appropriate:

In year one, Employer (GM) gives Employee a five year statutory stock option to purchase one share of GM for $100. At the time, shares of GM have a fair market value of $100. In year 3, when shares of GM have a fair market value of $150, Employee exercises the option by paying GM $100 for the share of stock. In year five, Employee sells stock to a 3rd party for $200.

There is no tax consequence to any party in year one. In year three, Employee does not recognize any income. GM may have capital gain income equal to the $100 received minus GM's basis in the share. In year five, employee will have a $100 capital gain. GM does not receive a deduction.

Numerous requirements must be met to qualify as a statutory stock option. They provide a tax advantage for the employee in that tax on the appreciation is deferred until sale and the appreciation is taxed at a capital gains rate. There is no tax advantage for the employer, however, because no deduction is allowed.

If the employer's marginal tax rate is as high as the employees' marginal tax rate, there may be no overall advantage in utilizing a statutory stock option.

Non-statutory Stock Option Plans.

A non-statutory stock option plan is simply one that does not meet the requirements of a statutory plan. Generally, the employee will realize ordinary income at the time that the option is granted. Income recognition is deferred, however, if the employees' rights to the stock are not vested or if the stock does not have a readily ascertainable fair market value. Although income recognition deferral is a general goal of tax planning, in this case, the advantage of deferral must be weighed against the disadvantage that the appreciation in the stock is taxed as ordinary income (up to 35% rate) rather than capital gain (usually a 15% rate).

In some circumstances, the employee may elect to recognize income at the time that the option is granted. By doing so, appreciation in the stock is taxed at capital gains rate when the stock is sold.

Employers are entitled to a deduction equal to the ordinary income recognized by the employee. The employer may not claim this deduction until the year the employee includes the income in his/her return. The employer may also have capital gain or loss when the option is exercised equal to the option price minus the employer's basis in the stock.

It is more difficult to value a stock option than the underlying stock. The stock option value is based on the value of the underlying stock and the option privilege. Accordingly, it is more likely that a stock option will not have a "readily ascertainable value." This means that the stock option is less likely to be immediately taxable to the employee (and deductible to the employer). This also means that an employee is less likely to be eligible to make an election to immediately recognize income (to avoid ordinary income taxation on stock appreciation).

For this reason, it is sometime preferable to issue stock bonuses rather than stock options.