Real estate capital gain: include property taxes or not?

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Sparkeee
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Real estate capital gain: include property taxes or not?

Post by Sparkeee »

Fellow Bogleheads,

I purchased a condo in 2005 in the same city I live in, in Texas. I had a family member living in the condo. I sold it in October last year.

The title agency sent me a 1099-S. It shows the date of closing (box 1), gross proceeds (box 2), address (box 3) and buyer's part of real estate tax (box 6).

The title agency also sent me a seller's statement. It shows the same data as in boxes 2 and 6 of the 1099-S, a number of adjustments, the realtor's commission, title/escrow charges, and miscellaneous charges. Among those miscellaneous charges, I see "2020 Property Taxes due": the title agency deducted them from my gross proceeds and paid them to the county's tax assessor collector. Once all added, I see the balance due to seller which corresponds to my net proceeds.

I am yet to file for 2020. On my 2020 tax return, I will be using the standard deduction.

My question: in calculating my capital gain, do I use the net proceeds from the seller’s statement as is or do I increase them by the “2020 Property Taxes due”?

The reason I am asking is because I think property taxes should be handled separately from capital gains on a federal tax return but I don’t know if I am correct or not.

Thank you in advance!
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grabiner
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Re: Real estate capital gain: include property taxes or not?

Post by grabiner »

IRS Publication 523, Selling Your Home lists which closing costs are part of the purchase or sale price.

Property taxes are only included if they are paid by the person who doesn't owe them. For example, if the annual property tax on the home is $2000 and the home is sold mid-year, the buyer and seller would normally each owe $1000 in taxes (which they can deduct as an itemized deduction). If the seller has paid the full $2000 already, the buyer would pay $1000 at closing but that $1000 does not increase the seller's capital gain or the buyer's basis. But if the seller has not paid the property tax and the buyer offers to pay the full $2000, the buyer's basis is increased by $1000. This makes it equivalent to the seller raising the price by $1000 and using that extra $1000 to pay the delinquent tax.
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Sparkeee
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Re: Real estate capital gain: include property taxes or not?

Post by Sparkeee »

Thank you David.

I think publication 523 applies to a homeowner selling their main residence.

In my case, I still own my main residence. The condo I sold was I think called a second residence in IRS lingo. As such perhaps https://www.irs.gov/faqs/itemized-deduc ... expenses-5 is more applicable. It reads:
State and local real property taxes are generally deductible.
  • Deductible real property taxes include any state or local taxes based on the value of the real property and levied for the general public welfare.
  • Deductible real property taxes don't include taxes charged for local benefits and improvements that directly increase the value of the real property, such as assessments for sidewalks, water mains, sewer lines, parking lots, and similar improvements.
  • Also, an itemized charge for services to specific property or people isn't a real property tax, even if the charge is paid to the taxing authority. You can't deduct the charge as a real property tax when it's a unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use), a periodic charge for a residential service (such as a $20 per month or $240 annual fee charged for trash collection), or a flat fee charged for a single service provided by your local government (such as a $30 charge for mowing your lawn because it had grown higher than permitted under a local ordinance).
  • The total deduction allowed for all state and local taxes (for example, real property taxes, personal property taxes, and income taxes or sales taxes) is limited to $10,000; or $5,000 if married filing separately.
I file as single and plan to use the standard deduction as itemizing would not make economical sense. In my situation, does the quoted text mean that I cannot deduct the property taxes from the gross proceeds?
water2357
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Re: Real estate capital gain: include property taxes or not?

Post by water2357 »

Property taxes are deductible if you owed them and paid them on Schedule A, if you take itemized deductions instead of the standard deduction. If you take the standard deduction, you can't deduct property taxes from your income. It doesn't matter how many properties you own, property tax is property tax.

If you sell a property, the prior resposne outlined when a "payment of property tax" to the seller by the buyer, who did not owe the property tax, increases the sales price.

Edit, if you owed the property tax that was paid, it is not an expense of sale. You don't add the property tax you pay the government each year to your basis.
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grabiner
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Re: Real estate capital gain: include property taxes or not?

Post by grabiner »

grabiner wrote: Sun Sep 26, 2021 9:11 pm IRS Publication 523, Selling Your Home lists which closing costs are part of the purchase or sale price.

Property taxes are only included if they are paid by the person who doesn't owe them. For example, if the annual property tax on the home is $2000 and the home is sold mid-year, the buyer and seller would normally each owe $1000 in taxes (which they can deduct as an itemized deduction). If the seller has paid the full $2000 already, the buyer would pay $1000 at closing but that $1000 does not increase the seller's capital gain or the buyer's basis. But if the seller has not paid the property tax and the buyer offers to pay the full $2000, the buyer's basis is increased by $1000. This makes it equivalent to the seller raising the price by $1000 and using that extra $1000 to pay the delinquent tax.
There is an example of the second situation in Publication 523, page 17 (although in that example, the home was sold before the tax was due).

But my description of the first situation is incorrect. If the seller has paid the full $2000 already, then the seller paid $1000 that the buyer owed. This decreases the effective sales price by $1000, so the seller's capital gain is reduced by that amount.

It's easier to see how this works with numbers. Say that the negotiated sales price is $200,000. If the property tax is semiannual, the buyer and seller each pay $1000 in property tax, the seller receives $200,000 at closing, and the sales price for purposes of basis and capital gain is $200,000. If the property tax is annual and has already been paid, the seller receives $201,000 at closing, but $1000 of that is a reimbursement for property tax that is owed by the buyer. The seller has the same amount of money as if he had paid only half the property tax, so the capital gain should be the same, based on a sales price of $200,000.

In both situations, the capital gain is based on the negotiated sales price; any property tax adjustment changes the money paid but not the capital gain.
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Sparkeee
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Re: Real estate capital gain: include property taxes or not?

Post by Sparkeee »

David: thank you for your further clarification.

water2357: thank you for your feedback, which clarifies and confirms to me that itemization is key. As I understand and agree, if one does not itemize, one does not get to deduct the property tax paid.

I will proceed with filing accordingly.
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