Realtors: How to Explain Capital Gains Tax to Your Clients

Realtors will be asked a slew of questions about capital gains taxes. Of┬ácourse you should help guide your clients, but it’s not good to say too much. Here’s how to find a balance and what to tell them.

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Our disclaimer: The information presented on this website is only a basic introduction to capital gains and other taxes associated with real estate sales. We strongly recommend that you advise your clients hire a professional to help you with their specific situation. The information provided here does not replace the IRS instructions for filing taxes. Incorrect filings could lead to large tax bills and penalties. Please have them hire a CPA or an EA before you make a decision about a real estate purchase or sale and also to prepare and file your tax returns.

Realtors should disclaim capital gains tax planning advice to their clients

Just like with our disclaimer above, realtors should clearly indicate to clients that they should seek advice form a tax professional before purchasing or selling real estate property.

I’m sure that I do not have to tell you how much more important it is to maintain good ethics with giving tax advice than it is to mislead clients just to make a sale. Successful realtors ignore the short term benefits and build their long-term brand on ethics and word of mouth.

You have too much to lose when lowering your standards, and that includes bad or incomplete tax advice.

With a long and prosperous career ahead of you, it really pays to learn what you can and should say about taxes and what you should not.

Just how much advice should realtors give to clients?

Obviously as a realtor you cannot simply stiff-arm clients when they ask you questions.

It is also obvious that it will really help your career as a realtor to have a basic understanding of the tax implications of buying and selling real estate.

After politely warning your clients that they should seek advice form a tax professional, you probably should guide them and be helpful in a very general manner.

If you would like to refer your clients to us for tax advice, click here.

As a Realtor, what specifically should I tell my clients about taxes?

Capital gains tax rates

As of 2020, capital gains tax rates are now 0%, 15%, or 20% depending on your total income (including the capital gain).

Some taxpayers will fall into the 15% category, but if total income exceed $425,000 or so (or half of that if filing separately), it may click up to the 20% range. This INCLUDES the income from any gain on the sale itself.

Remember, again, that “income” does not only include wages, but it mostly likely includes income from all sources, including income from the sale.

Like-kind exchange of property

A like kind exchange is currently ONLY available for business and investment property. So with real estate, it mostly applies only to rentals.

The tax code formerly allowed home owners (of non-rental property) to identify and buy a new home within a certain amount of time to avoid capital gains tax on a sale of their main home. This part of the tax code for a principle residence has been extinct for quite a few years now. It no longer exists for personal real estate property.

The sale of principle residence exclusion

realtors and capital gains taxReplacing the like-kind exchange for personal property is the “sale of principle residence exclusion”.

A taxpayer qualifies when they sell their main home that they lived in for 2 out of the most recent 5 years, they did not rent out the property, and they had not claimed another exclusion within the last two years.

There are some additional restrictions and exemptions but those is the general guidelines for the qualification rules.

Click here to read more about them.

When they qualify, taxpayers get $250,000 of their capital gain excluded form tax. Married taxpayers get $250,000 each so it’s $500,000 total.

For property that was rented (if the taxpayer was a landlord) the rules change, but they still might qualify for some or all of the exclusion. This part of the tax code is complicated.

Adjusting basis for capital improvements and the cost of sale

It is elementary that if you buy a property for $200,000 and sell it for $300,000 that you will see a $100,000 capital gain.

But this gain can be reduced by transaction costs and capital improvements.

In the above example, if the sellers spent $20,000 on major repairs and $7,000 in closing expenses, their gain will only be $73,000.

If audited by the IRS or state tax agency, the owners may have to produce proof to substantiate the capital improvements.

The sale of rental property

The gains on the sale of property that was rented out is much more complicated, as it involves un-recaptured depreciation.

This involves a tax rate other than the capital gains tax rates discussed above. It also involves a complicated worksheet to calculate the sale of principle residence exclusion – which will still not offset un-recaptured depreciation

Calculating the basis when a property has been rented is extremely complex.

When you have a client who wishes to sell property that was rented at any time, it’s probably best to refer them to a tax professional.

I want you to like me, but even though it may not be great for making the sale, it is important to let them know that they may have a much larger gain and tax bill that they might have been expecting.

Rules might change for property held in trusts, corporations, and partnerships

It is important to realize that all of the rules as discussed above might change based on entity ownership vs. individual ownership.

Will any of your clients need help with the Mortgage Credit Certificate? Click here to read about how to advise them.

If your clients need professional help with preparing and filing their income taxes, they can contact us here.

Please note that we do charge those that are not our tax clients for tax advice and planning calculations.

Thank you for reading and I hope you have a long and prosperous career as a realtor.