Whether you're considering selling your home now or in the future, understanding the tax implications of this significant financial decision is crucial. The sale of your primary residence can have various tax consequences, and being informed can help you make the best choices for your financial well-being. This newsletter aims to provide you with valuable insights into the tax aspects of selling your home, ensuring you are prepared and confident in your decisions.
When you sell your primary residence, you may be subject to capital gains tax on the profit from the sale. The capital gain is calculated as the difference between the selling price of the home and its purchase price (plus any improvements made over the years). However, the tax code provides some relief for homeowners through the primary residence exclusion.
The primary residence exclusion allows homeowners to exclude up to $250,000 of capital gains from their income if they are single, or up to $500,000 if they are married and file jointly. To qualify for this exclusion, you must meet the following criteria:
To determine your capital gains, subtract your home’s adjusted basis from the sales price. The adjusted basis includes the original purchase price plus the cost of any improvements made to the property as well as closing costs. For example:
In this scenario, if you are single, you could exclude the entire $250,000 capital gain from your taxable income, owing no capital gains tax.
If you qualify for the primary residence exclusion and your gain is below the exclusion limit, you typically do not need to report the sale on your federal tax return. However, if your gain exceeds the exclusion limit or you do not qualify for the exclusion, you must report the sale on Form 8949 and Schedule D of your tax return.
Effective tax planning can help you maximize the benefits of selling your primary residence. Here are a few strategies to consider:
While the primary residence exclusion is generous, there are several special considerations to keep in mind:
Selling your primary residence is a significant financial decision with important tax implications. By understanding the rules and planning ahead, you can make informed decisions that protect your financial interests. If you have any questions or need assistance with your financial planning, please do not hesitate to contact us. We are here to help you navigate the complexities of the tax code and achieve your financial goals.
Thank you for reading,
The Canty Financial Team
Bill Canty, CFP®, CPA, Financial Planner
Ed Canty, CFP®, Financial Planner
Joe Canty, CFP®, Financial Planner
Tina Alteri, CPA, Tax Advisor
Maureen Walsh, EA, Tax Advisor
Tax planning is a cornerstone of a solid retirement plan, ensuring you can enjoy retirement while maximizing the savings accumulated throughout your career. Understanding how different income sources are taxed, and leveraging strategies to minimize these taxes is critical. Additionally, the guidance of a trusted financial advisor who knows your situation, understands the complex tax landscape, and acts as a sounding board for your ideas and questions is indispensable.
Retirement income has unique tax implications, depending on the account type or investment:
The strategy you use to withdraw from your retirement savings plays a crucial role in managing your tax impact. Typically, prioritizing withdrawals from taxable investment accounts first, to take advantage of potentially lower capital gains rates, is advisable.
Then, accessing funds from tax-deferred accounts like 401(k)s and traditional IRAs can help, as these are taxed as ordinary income upon withdrawal.
Integrating Roth IRAs into your strategy adds valuable tax diversification and flexibility, given that qualified distributions are tax-free.
Understanding the nuances of Required Minimum Distributions (RMDs) and selecting the appropriate investments to liquidate are also essential for minimizing tax liabilities. At Canty Financial, we emphasize tax-efficient withdrawal planning as a vital part of our retirement planning services, aiming to enhance your financial outcome in retirement.
Considering tax implications prior to making investments can lead to substantial tax savings and provide increased after-tax returns. The choice between investing in traditional IRAs versus Roth IRAs, for example, should be influenced by your current and expected future tax situations.
Contributions to Health Savings Accounts (HSAs), if eligible, also offer tax benefits and can act as a substitute for your IRA or other tax-deferred accounts. Contributions to HSAs are tax deductible and if used for qualified medical expenses distributions are tax-free. Any distributions from HSAs after age 65 are considered ordinary income, but not subject to a 10% penalty.
Exchange traded funds are more tax efficient and have less capital gain distributions compared to similar mutual funds, allowing you to keep your money invested rather than having to pay large tax bills each year. We construct portfolios of ETFs at Canty Financial, giving our clients more tax-advantageous portfolio structures.
Tax-loss harvesting is a strategy to offset capital gains with losses reducing your net tax burden. At Canty Financial, we leverage our portfolio rebalancing software, 55IP, to automate this process. Tax loss harvesting opportunities are consistently analyzed every 30 days, allowing our clients to take advantage of fluctuations in the market. If a fund can be sold at a loss, we will realize the loss by selling that ETF and then purchasing a very similar fund. This allows our clients to take advantage of the loss while remaining fully invested at all times. This approach is particularly beneficial for managing large, unrealized gains and for transitioning accounts to a new portfolio with minimal tax impact.
Charitable giving, including Qualified Charitable Distributions (QCDs) from IRAs, can reduce taxable income and is highly effective if you are subject to RMDs or if you take the standard deduction. Donating appreciated assets directly to charity can also circumvent capital gains taxes, offering a tax-efficient way to support charitable causes.
We assist clients in developing estate planning strategies that minimize transfer taxes and facilitate the efficient transfer of wealth to heirs. This may involve the use of trusts, beneficiary designations, transfer on death titling, and strategic gifting. Understanding the rules and benefits of annual gifting can further reduce tax bills.
State taxes can also affect retirement income. For instance, New York State does not tax Social Security or public pensions and offers a $20,000 exclusion for retirement account withdrawals.
Certain income such as interest from U.S. government bonds are also tax-exempt in many States.
Planning for State taxes, especially if considering a move in retirement, is crucial for minimizing overall tax burdens.
Tailoring tax planning strategies to individual circumstances requires professional insight. The landscape of tax laws and personal situations is ever-changing, highlighting the need for ongoing tax planning.
At Canty Financial, we prioritize the integration of tax considerations into your comprehensive financial plan, covering areas such as retirement, estate planning, and investment management. Our approach ensures that our clients experience no gap between their tax strategy and their broader financial decisions, a common issue when advisors lack sufficient tax knowledge.
Engaging with a financial planner or tax professional goes beyond mere tax compliance, it's about maximizing your financial potential in retirement. By understanding and applying these strategies, retirees can significantly reduce their tax burdens, securing a more prosperous and worry-free retirement.
Bill Canty, CFP®, CPA, Financial Planner
Ed Canty, CFP®, Financial Planner
Joe Canty, CFP®, Financial Planner
Tina Alteri, CPA, Tax Advisor
Maureen Walsh, EA, Tax Advisor
It’s important to understand the tax implications of investment decisions because taxes can have a significant impact on your investment returns. Here are some real-life examples we’ve seen of tax investment mistakes.
There are several common tax mistakes associated with IRAs and Roth IRAs, including:
Taking a large distribution out of a retirement account to buy a house can have several negative consequences, including:
Understanding your cost basis is essential before selling an investment. The cost basis is the original purchase price of an asset. When you sell an asset, you will owe taxes on any gain above the cost basis. If you sell an asset for less than the cost basis, you may be able to claim a loss for tax purposes.
If you sell an asset after holding it for less than a year, any gains will be considered short-term capital gains and will be taxed at your ordinary income tax rate. However, if you hold the asset for more than a year before selling it, any gains will be considered long-term capital gains, which are taxed at a lower rate.
For this reason, understanding your cost basis is crucial to accurately calculate your tax liability and avoid overpaying or underpaying taxes. If you do not know your cost basis, you may end up paying more in taxes than you owe or risk facing penalties for underreporting your income.
As an elderly person, it can be better to not realize gains on investments and instead hold onto them to get a stepped-up basis because it can potentially reduce the capital gains tax liability for you and your heirs.
When an individual dies, their heirs generally receive a "stepped-up basis" for inherited assets, including investments. This means that the basis of the asset is "stepped up" to the fair market value on the date of the individual's death, regardless of the original purchase price. For example, if an individual purchased a stock for $10 and it is worth $50 at the time of their death, their heirs would inherit the stock with a basis of $50.
If the heirs were to sell the inherited asset, they would only owe capital gains tax on any increase in value that occurs after the date of the individual's death. This can potentially reduce or even eliminate the capital gains tax liability. However, this strategy should be considered in the context of the individual's overall financial situation and goals, as there may be other factors that weigh against holding onto investments for an extended period.
Frequent large capital gains distributions out of mutual funds can erode investment returns over time. Mutual funds can issue capital gain distributions to the fund’s shareholders at any time. These distributions are taxable, even though the shareholder did not sell any portion of the mutual fund. Depending on the size of the distribution and the shareholder's tax bracket, the tax liability can be significant, reducing the overall investment return.
On the other hand, ETFs (Exchange Traded Funds), offer more control over taxable events. Most ETFs do not have capital gain distributions, so taxpayers are less likely to be hit with a large tax surprise at the end of the year. Shareholders of ETFs realize gains when they sell, so they have much more control over when they would like to realize a gain. At Canty Financial we build our portfolios primarily using ETFs with the goal to maximize our client’s after-tax returns.
Overall, it's important for investors to be aware of the potential impact of capital gains distributions on their investment returns over time. If investors are forced to sell investments to pay a large tax bill on a capital gain distribution each year, then it's highly likely to have a negative impact on long-term returns.
If you have any questions about the tax implications of your investments, please feel free to reach out, we are here to help.
Bill Canty, CFP®, CPA
Ed Canty, CFP®, Investment Advisor
Joe Canty, Investment Advisor
Maureen Walsh, EA, Tax Advisor
Tina Alteri, CPA, Tax Advisor
