What is Capital Gains Tax?
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Capital gains tax is a tax on the profit you make when you sell something for more than you paid for it.
 
If you sell assets like a house, stocks, or other investments for more than you purchased them, you may owe capital gains tax. This tax typically applies can only when you sell the asset and realize a profit.
How to Calculate Capital Gains Tax
 
Formula: Net Selling Price – Adjusted Cost Basis = Capital Gains
 
Expanded Formula: (Selling Price – Cost of Selling) – (Cost Basis + Improvements – Depreciation) = Capital Gains
 
Capital Gains Tax: Calculated by multiplying your capital gain by the applicable tax rate, which varies based on your tax bracket. Taxes may apply at the federal, state, and potentially Net Investment Income Tax (NIIT) levels. 

Definitions:

Cost of Selling: Includes realtor service costs and closing costs.

Cost Basis: The price you originally paid or the value when the property was transferred to you.
 
Adjusted Cost Basis: Original cost basis adding improvement value or subtracting depreciation on investment properties:
 
Adding Improvements (with receipts): Renovations, additions, or upgrades that increase the property’s value (must have documented receipts).

Subtracting Depreciation: A reduction in the value of improvements, claimed for investment properties over time.

Example

 

1)  Sale price - Cost of selling = Net selling price

  $1,000,000 - $70,000 = $930,000

 
2)  Cost basis + Improvements = Adjusted cost basis
  $200,000 + $ 100,000 = $300,000
 
3) Net selling price - Adjusted cost basis = Capital gains
      $930,000 - $300,000 = $630,000
 
4)  Capital gains * Capital gains tax rate = Capital gains tax
   $630,000 * 30% = $189,000
 
Disclaimer: The information provided is for general informational purposes only and should not be considered financial, tax, or legal advice. We strongly recommend consulting a Certified Public Accountant (CPA) or qualified tax professional to understand how tax laws apply to your specific situation. 
 

Capital Gains Taxes

State Capital Gains Tax

The state of Hawaii has a 7.25% capital gains tax rate

Federal Capital Gains Tax

For single filers, federal capital gains rates may apply:
 
0% rate: Taxable income up to $47,025

15% rate: Taxable income over $47,025 and up to $518,900

20% rate: Taxable income over $518,900
 
***Capital Gains are included in your taxable income
 

Net Investment Income Tax (NIIT)

The Net Investment Income Tax (NIIT) is 3.8% and applies if your modified adjusted gross income (MAGI) exceeds:
 
- $250,000 for married filing jointly or qualifying surviving spouse

- $125,000 for married filing separately
 
- $200,000 for single or head of household
 
***Capital Gains are included in your MAGI
 

Primary Residence Capital Gain Tax Exclusion

IRS section 121 allows you to have an exclusion on your capital gains. You may qualify for $250,000 for a single person and $500,000 for married, filing jointly on your capital gains.

 

To qualify for this exclusion you must have lived in your home for at least two out of the last five years before its sale date. In addition, if you sell a home and use the exclusion, you generally need to wait at least two years before you can use it again on a different home.

 

The IRS may verify your primary residence (the home you live in) by checking the addresses listed on your:

- U.S. Postal Service
- Voter Registration Card
- Federal and State Tax returns
- Driver’s license or car registration

 

Source: https://www.irs.gov/taxtopics/tc701

Defer Capital Gains Tax

A 1031 exchange allows owners of investment properties to defer paying capital gains taxes when selling a property. Instead of selling and paying taxes on the gains, the proceeds from the sale can be used to purchase another “like-kind” investment property, deferring the taxable gains.

 

A 1031 Exchange applies to properties held for business or investment purposes. However, you can change the property's intent. For example, you could move out of your primary residence, and rent it for two years making it an investment property. Then it could be eligible for a 1031 exchange.

Eliminate Capital Gains Tax

A step-up in cost basis is a tax benefit that can help eliminate capital gains taxes. 

 

A step-up in cost basis happens when you inherit a property. The property’s cost basis is adjusted to its market value when you inherit it, not the original price it was purchased for. 

 

Example:
If your parents bought a house for $200,000 and it’s worth $500,000 when you inherit it, the cost basis steps up to $500,000. If you sell it for $500,000, there’s no taxable gain, so you owe no capital gains tax.

 

Real estate planning can create strategies that allow you to use 1031 exchanges throughout your life to defer capital gains taxes. Upon your passing, your children would inherit your real estate with a step-up in cost basis, effectively eliminating capital gains taxes for your family.
 
 

Why Gifting Your Property Can Lead to Higher Taxes

When you gift property while alive, the recipient takes on your original cost basis (the amount you paid for the property). This is called a carryover in cost basis.

 

For example, if your mom purchased a home for $100,000 and gifts it to you while it’s now worth $800,000, you inherit her original cost basis of $100,000. If you sell the property for $800,000, you could owe taxes on the $700,000 profit. At a 30% capital gains tax rate you would now owe $210,000.