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.

Investment Capital Gains

Have you bought any mutual funds this year or late last year while the market was doing its skyrocket thing? Last year it was hard to lose money. This year it has been easy.

You should be calling your mutual fund (they all have 800 numbers) to find out if and when they plan to pay their capital gains and dividends. You might say to yourself, they won't be paying anything this year because the fund is selling for less now than it did at the beginning of the year. Think again. It is very probable that the mutual fund manager took profits on many high flyers that he bought cheap last year. According to the way funds are set up those profits are taxable to holders of the mutual fund and not to the fund itself.

It is possible you bought a fund at $40 per share that is now selling at $30 per share and be hit with a 25% capital gains distribution of $10. On paper you now have a $10 per share loss and a tax bill based on the $10 per share distribution. That is adding injury to insult.

With this as a possible scenario it might be prudent to sell your fund for less than you paid for it. You should work the numbers with your accountant to see if this might reduce your tax bill. But you have to do it now. You can't wait until after the mutual fund declares its capital gains distribution. This is especially true if you have purchased any high tech or international funds during the past year. You can carry losses forward to next year to offset against profits and distributions next year.

The greatest numbers of mutual funds declare these distributions near the end of the year, usually starting in November with most of them in December. The rumors I hear are that the distributions will be early this year because of the poor performance of the majority of funds.

This applies to everyone who does not have a tax shelter of some kind such as a 401k, IRA, SEP or other similar investment vehicle.

One piece of advice I want you to heed. Don't buy any mutual funds now because they are "cheap". Wait until after they declare their capital gains and dividend distributions. You could be whacked with a big tax bill.

Tax Benefits of Buying Investment Properties

Property investing has proved itself is a wealth creation vehicle for many generations now. Many families have built their wealth on property acquisitions over a long period of time which now places them in an enviable financial position.

As it becomes clear that current superannuation plans may leave many retirees in a less than comfortable position, the property market provides an alluring alternative. But it is not just a simple matter of buying a property and rubbing your hands with glee at the inevitable positive returns. Careful professional advice is required and tailoring an investment strategy to suit your individual circumstances is vital.

Many first-time investors make glib references to the tax advantages that attached to property investment but a few simple points still need to be clarified. In this article will examine the important taxation considerations of property investment including negative gearing, depreciation, capital gains tax, and how tax benefits can make your investment pay.

* Negative gearing. This term simply describes the fact that you are borrowing money to make an investment. When the costs of the investment are higher than the return you achieve, you are said to be negatively geared. For example when an investment property has an annual net rental return which is less than the interest charged on the investment loan, the property is said to be negatively geared. This loss of income from the property is eventually made up over time as the property value increases. In the meantime however a high income earner can benefit from this as the losses can be offset against their taxable income. Although you should never specifically aim for a negative gearing position, you can take advantage of it if it suits your personal circumstances, and if the properties capital growth potential is going to be positive and greater than the cost of funds, otherwise it is a futile endeavour.

* Depreciation. One of the tax advantages in owning an investment property is that you can claim for depreciation of certain items and reduce your taxable income in the process. Things like refrigerators, furniture and cooktops can be written off over the effect of life of the asset. Naturally, you need specialist advice here and an accountant is the obvious choice. The Australian taxation office determines the schedules and allowances but you still need the services of an accountant and a quantity surveyor to make sure you get the greatest depreciation deduction. New properties have greater depreciation. You can claim two components, the building as well as the fixtures & fittings.

* Capital gains tax. This is charged on the capital gains that your investment property enjoys over the period you own it only if you sell it You become liable to pay the capital gains tax where your gains exceed your capital losses in any income year. This is where specialist advice really comes into its own as you can take advantage of capital losses if you sell the property at the right time. This is a very complex area that your specialist property adviser or accountant can assist you with. Otherwise if you are building wealth, you can get your property revalued and lend against its increased value to purchase another property without triggering capital gains tax.

* Making your investment payoff. After you have owned an investment property for a number of years, you are likely to enjoy substantial capital gains. Additionally, your rental income over the same time can greatly assist loan repayments to a point where it there is very little effect on your cash flow, or to the point of being positively geared. Reviewing your position at that time, you may be ready to add another property to your portfolio.

Take advantage of these tips and plan your property investment strategy only after consultation with experts.

Selling Your Investment Property in 2010 Could Save You Thousands in Taxes

If you are an investor looking to sell one or more of your real estate holdings, you might want to consider completing the sales transaction in the next year. At the end of 2010, tax cuts put in place by President Bush will be reset to standard income tax rates and you will lose your opportunity to take advantage of the lower rates.

As an investor looking to sell a house fast, you are most likely already familiar with capital gains taxes, but most home buyers are not. Therefore, the decision to buy houses in PA is not made because of the capital gains tax reductions that you, the seller, will get if the property sells before the end of 2010.

The current capital gains tax rate is actually a two-fold calculation. If you are selling a property for which you have claimed depreciation, then you must be aware of the total amount of the depreciation claimed. Many investment home buyers bought properties as part of a we buy houses type program and want to sell the house now. In that case, the capital gains tax rate will be 10%.

On the other hand, if you have claimed depreciation be aware that when you find a home buyer, you will be taxed at 25% for the amount that you claimed in depreciation when you sell your house now. The advantage of selling is still in your favor however, since the remaining sales revenue will be taxed at the lower 10% rate.

This advantage means that you will keep more of the profits when you sell your house now, instead of waiting until after the end of 2011. Whether you pay just the lower amount of capital gains tax, or you split the percentage rate, you will still likely earn more from the sale in the next year than at any point in the future.

The market is definitely leaning toward sellers right now, because there are many individual home buyers in Philadelphia and investors looking to buy houses in PA. They are looking for deals, and although the idea of selling at a lower price does not always seem appealing in comparison to waiting a year or so to sell, today it is not a bad idea to sell a house fast for a lower price. This is because even at a lower selling price, your property is going to bring you larges profits than if you wait a year and sell for a significantly higher price.

Keep this information in mind as you make decisions regarding your real estate investments, particularly if you are already planning to sell in the near future. There hasn't been a better market for home buyers in years, and fortunately for the investor, prices are higher than they were over the last few years and there is a significant profit to be made by selling in the next year.

Buying Investment Property in Australia - What You Must Know About Tax, GST and Capitals Gains

Investment properties are a great long-term investment. However, if you're considering buying residential or commercial investment property you need to be up to speed on important tax, GST and capital gains rules.

That way, you know exactly where you can save money - and what you're up for depending on your situation.

Tax rates if you don't have an Australian Business Number (ABN)

If you buy a residential property you don't need an ABN. However, if you ever purchase any goods or services for the property that cost more than $50, your supplier has to include an ABN on their invoice, or 48.5% of your payment will have to go to the tax office.

For example, if an electrician invoices you $500 to install some lights and there's no ABN on the invoice, you pay him $257.50 and withhold $247.50 for the Tax Office.

If you own a commercial property, you definitely need an ABN, or the business renting your property has to withhold 48.5% of their rent for tax - and we don't want that!

GST and commercial property rent

You usually only have to worry about GST when you buy a commercial property. If your:

gross rent, excluding GST, is more than $50,000 a year, you need to be registered for GST.
gross rent is less than $50,000 you can voluntarily register for GST.

And if you are registered for GST you:

must include it in the rent you charge
can claim GST credits for any rental expenses
need a tax invoice to claim the GST credits on any purchases you make
must give your business tenant a tax invoice so that they can claim the GST in the rent.

GST and your renter

If your renter is registered for GST and they use the premises solely for business:

the amount of rent will include GST
you can claim GST credits.

If your renter is not registered for GST or the rent is partly for private use:

GST is based on the market value not the amount they pay you.

For example, say you rent office space to someone who's not registered for GST and they pay you $220 per week, but the market value rent is $440 per week. You'll still need to account for $40 GST so you can claim GST credits.

Are you earning additional income from the property?

On top of rent, there are other potential income streams to remember, such as:

profit generated from the use of the rental property.
bond money if you entitled to keep any
insurance payouts for things like such as compensation for lost rent

Claiming on property expenses

At the other end of the scale, there are the inevitable expenses such as:

maintenance costs
body corporate fees and charges.

What you might be able to claim expenses for

In addition, there are things you might be able to claim for over a number of years including:

borrowing expenses
amounts for decline in value of depreciating assets
a capital works deduction for the cost of capital improvements
capital repairs once the cost has been charged to the appropriate fund.

What you can't claim expenses for

Make sure you don't include:

time rented below commercial value. For example, if you let your daughter run her business out of there at no cost until she gets on her feet, you can't claim deductions for this period.
levies paid to a special fund for particular capital expenditure.
special contributions for major capital expenses to be paid out of the general purpose sinking fund.
costs of buying and selling the property (see capital gains below)

More than one owner

If you own your property with someone else then rental income and expenses must be attributed to each co-owner according to your legal interest in the property regardless of any other agreement you might have.

Capital gains tax on rental property

Capital gains tax is the tax you pay on any gain made on an income-producing asset eg investment properties. Depending on when you bought your rental property, capital gains tax might apply when you sell it.

Some of your expenses can reduce your capital gains tax. However, there are some expenses - like the costs of buying or selling the property - you can't claim as deductions.

And if the property is owned by more than one person, each of you may have to pay capital gains tax based on your legal interest in the property.

Keep records of everything

You need to keep records of all your income and expenses relating to your rental property. And hold on to them for five years after you sell it.

For capital gains tax purposes, you must have records stating whether you:

bought the property
inherited it
received it in a divorce settlement or as a gift
make improvements to property.

Note: The information within this text and any reference to Australian taxation issues are intended as a guide only. You should seek accounting and tax advice based on your personal situation.

IRS Capital Gains - This Tax is You Watching Your Investment Dollars Going Away

The IRS capital gains tax is the method the US government uses to tax any profit you may incur from being a savvy investor.

Capital gains and losses from a person's investments in capital assets do not occur in the purchasing and owning assets. The only time there is a tax liability is when a capital is sold for a profit. This includes financial investment like stocks and bonds along with personal assets like boats and other recreational items. These types of capital assets are divided into short term and long term capital gains and losses.

A long term capital gain or loss occurs when a capital assets is held for more than one year before it is sold. A short term capital gain or loss is when the capital asset is sold within one year of it purchase. The major distinction between the two is the rate at which they are taxed. The short term capital gains tax is at a higher rate a majority of the time.

There are other capital assets that are taxed differently than the short term and long term gains, these are items that are considered art or collectibles. These are taxed at the highest rate of any asset upon their sale. The final tax rate is dependent on the tax payers overall income level.

There are also capital losses. The IRS does not require you to report these because they cannot tax them. If you have a capital loss, you can report them but the amount is limited to $3000 per filing year. If your losses are greater than they must be carried over to the next tax filing year.

This is the basics of the IRS capital gains and losses explanation. More information can be found at the IRS website.

Of course, the above is not legal or accounting advice - it is for informational purposes only. Before making any decisions regarding legal or tax matters, it is vital that you consult a licensed professional lawyer or tax accountant.

1031 Exchanges - The Legal Way To Defer Investment Property Capital Gains Tax

With the booming property prices of recent years, more and more people are finding themselves facing a large tax bill when they come to sell their investment properties. However, did you realize that there is a perfectly legal way of deferring payment of such taxes by utilizing the advantageous 1031 tax code that was introduced by the IRS in the early 1990s?

A 1031 exchange is a way of deferring payment of capital gains tax on certain types of real estate. Normally when an investment or business property is sold, capital gains tax has to be paid. However, with 1031 exchanges, by replacing the old property with a like kind property, within set time limits, payment of capital gains tax can be avoided.

Under the 1031 exchange real estate rules, a seller must have held a property for at least one year and a day for it to qualify. Another requirement is that both old (relinquished) and new (replacement) 1031 exchange properties must be of a likekind - either rental properties, vacant land, trade, business or investment properties.

1031 exchanges must be completed within strict time limits. There is a 45 day Identification Period from the transfer of the old property, in which a replacement property must be identified. The 1031 exchange rules stipulate that the exchange must be completed within the 180 day Exchange Period.

The 1031 exchange real estate issues are complex, so it is imperative to seek professional advice from a tax advisor or qualified intermediary who can assess your specific circumstances and explain other issues such as the reverse 1031 exchange or TiC rules. With careful financial planning, you can reinvest your capital gains in future real estate investments, thereby allowing you to leverage your money more efficiently and to reap greater financial benefits.

Need More Income from Your Investment Property?

The goal of every real estate investor is to see their property appreciate in value and to have it generate a positive cash flow. The appreciation normally takes care of itself if the property is of good quality, in a good location, and is held over a long enough period of time. Just like the stock market, real estate has proven to go up way more than it goes down over time.

The positive cash flow component is not always a given though. Ask any seasoned investor, and unless the property is owned free and clear, there have probably been times when he's had to dip into his own pocket to pay for some aspect of his rental. Who hasn't seen a raise in homeowner's fees, property taxes, an outlay of cash for a new roof, plumbing, paint, carpet, appliances, or a length of time supporting it between tenants.

So, what if you're nearing retirement age and see the need for increased and steady income? You may even look forward to taking a permanent break from the "joys" of hands-on property management. We all deserve to reap the rewards of our labors, right?

Basically, to meet these goals, one can do one of two things.

1. Sell the property, pay all the capital gains taxes, recaptured depreciation, etc. and pocket what is left. To receive an income, one would have to either live off whatever interest/gains your proceeds produced, or begin depleting your funds to provide you with the amount of monthly income you deem necessary. Depending on your age and financial needs and whether or not you desire to leave as large a legacy as possible, this approach may or may not work for you.

2. Employ a strategy that will defer the payment of any tax or depreciation. Let all of your gains continue to work for you throughout the course of your retirement and into the next generation. Yet, you will still get a significant and partially tax deductible monthly income.

What strategy is #2? If your property is over a million and you are not a young retiree, you might consider a Private Annuity Trust. You will get monthly income for the rest of your life, but you will be depleting your asset and only spreading out the repayment of capital gains tax over a longer period of time. That is a simplification of a complex agreement, but that is the gist.

A better option may be a 1031 exchange into a tenant in common (TIC), Basically, you exchange your property for a deeded partial interest in a grade A commercial property. You sign a contract with a property management company, and in turn receive a monthly income (typically 6-7% of your total equity). You never have to deplete your asset, and it can pass to your heirs at the stepped up basis.

The 1031/TIC exchange is a fairly new concept, sanctioned by the IRS in 2002. It is projected that the influx of property assets into this type of exchange will be close to 5 Billion dollars in 2005. That's a lot of equity. Why not let your equity continue to work for you instead of parting with a lot of profits that would take you years to replace.