Thinking About Taking Year End Tax Losses? Don’t Make These Mistakes

Given the stock market’s performance this year, you may be thinking about taking some losses—otherwise known as tax loss harvesting. It’s a good strategy when investments in a taxable account decline, but you want to avoid some traps.

Tax loss harvesting is simply selling investments in taxable accounts that have paper losses so the loss becomes tax deductible.On your tax return, capital losses first offset any capital gains you have for the year. Each dollar of taxable loss you recognize allows you to recognize a dollar of capital gains tax free.

If capital losses for the year exceed capital gains, up to $3,000 of excess losses can be deducted against the other income on your tax return. When capital losses for the year exceed capital gains plus the $3,000 deduction, the excess losses can be carried forward to future years to be used in the same way.

Selling a losing investment can shelter other gains or types of income from income taxes and frees up the capital to be invested in something else.

Of course, you probably purchased the investment because you expected it to appreciate. If you still like the investment’s longer term prospects, you can buy it back after selling it. But you have to avoid the wash sale rule.

The wash sale rule says you have to wait more than 30 days (not 30 days—more than 30 days) to repurchase the investment or a substantially identical one. If you don’t wait long enough, the loss isn’t deductible. It’s added to the basis of the new investment and effectively the deduction is delayed until that investment is sold.

The wash sale rule also applies if you bought the substantially identical investment 30 days or less before you sold the losing investment.

So, the first rule is to avoid buying a substantially identical investment within 30 days of selling the investment.

You can buy an investment that isn’t substantially identical within 30 days of the sale. For example, you can sell one tech stock and purchase a different tech stock, even one in the same sector. Or sell a biotech stock and buy shares in a biotech ETF.

Another action you can’t take is to buy a substantially identical investment in an IRA or 401(k). The IRS ruled some years ago that the wash sale rule is violated when an individual investor sells an investment in a taxable account and within 30 days buys the same investment in an IRA or 401(k). It’s one case when the IRA isn’t treated as a separate taxpayer.

Here’s a related point. When you have a losing investment in an IRA, you won’t be able to deduct the loss on your individual tax return. A loss in an IRA is deductible only in the rare case when you fully distribute all your IRAs of the same type (traditional or Roth), and the proceeds are less than your aggregate cost basis in the IRAs.

Source: Thinking About Taking Year End Tax Losses? Don’t Make These Mistakes

Critics by Hayden Adams

Tax-loss harvesting—offsetting capital gains with capital losses—can lower your tax bill and better position your portfolio going forward. Even in the best of times, not every investment will be a winner. Fortunately, a losing investment does have a silver lining: You may be able to use your loss to lower your tax liability and better position your portfolio going forward. This strategy is called tax-loss harvesting, and it’s one of the many tax-smart strategies that investors should consider.

Tax-loss harvesting generally works like this:

  1. You sell an investment that’s underperforming and losing money.
  2. Then, you use that loss to reduce your taxable capital gains and potentially offset up to $3,000 of your ordinary income.
  3. Finally, you reinvest the money from the sale into a different security that meets your investment needs and asset-allocation strategy.

The general principle behind tax-loss harvesting is fairly straightforward, but it’s best to plan your strategy to avoid some common pitfalls.

The basics of tax-loss harvesting

Imagine you’re reviewing your portfolio, and you see that your tech holdings have risen sharply while some of your industrial stocks have dropped in value. As a result, you now have too much of your portfolio’s value exposed to the tech sector. To realign your investments with your preferred allocation, you sell some tech stocks and use those funds to rebalance. In the process, you end up recognizing a significant taxable gain.

This is where tax-loss harvesting comes in. If you also sell the industrial stocks that have declined in value, you could use those losses to offset the capital gains from selling the tech stocks, thereby reducing your tax liability.

In addition, if your losses are larger than the gains, you can use the remaining losses to offset up to $3,000 of your ordinary taxable income (for married couples filing separately, the limit is $1,500). Any amount over $3,000 can be carried forward to future tax years to offset income down the road.

For example, let’s say you recognize a gain of $20,000 on a stock you bought less than a year ago (Investment A). Because you held the stock for less than a year, the gain is treated as a short-term capital gain and will be taxed at the higher ordinary-income rates rather than the lower long-term capital-gain rates, which apply to investments held for more than a year.

At the same time, you also sell shares of another stock for a short-term capital loss of $25,000 (Investment B). Your $25,000 loss would offset the full $20,000 gain from Investment A, meaning you’d owe no taxes on the gain, and you could use the remaining $5,000 loss to offset $3,000 of your ordinary income. The leftover $2,000 loss could then be carried forward to offset income in future tax years. Assuming you’re subject to a 35% marginal tax rate, the overall tax benefit of harvesting those losses could be as much as $8,050. Let’s take a look at how this works.

Using an investment loss to lower your capital-gains tax

By offsetting the capital gains of Investment A with your capital loss of Investment B, you could potentially save $7,000 on taxes ($20,000 × 35%). Because you lost $5,000 more than you gained ($25,000 – $20,000), you can reduce your ordinary income by $3,000, potentially lowering your tax liability an additional $1,050 ($3,000 × 35%) for a total savings of $8,050 ($7,000 + $1,050). You could then apply the remaining $2,000 of your capital loss from Investment B ($5,000 – $3,000) to gains or income the following tax year.

Issues to consider before utilizing tax-loss harvesting

As with any tax-related topic, there are rules and limitations:

  • Tax-loss harvesting isn’t useful in retirement accounts, such as a 401(k) or an IRA, because you can’t deduct the losses generated in a tax-deferred account.
  • There are restrictions on using specific types of losses to offset certain gains. A long-term loss would first be applied to a long-term gain, and a short-term loss would be applied to a short-term gain. If there are excess losses in one category, these can then be applied to gains of either type.
  • When conducting these types of transactions, you should also be aware of the wash-sale rule, which states that if you sell a security at a loss and buy the same or a “substantially identical” security within 30 days before or after the sale, the loss is typically disallowed for current income tax purposes.

Even if you don’t have capital gains to offset, tax-loss harvesting could still help you reduce your income tax liability.

Let’s say Sofia, a single income-tax filer, holds XYZ stock. She originally purchased it for $10,000, but it’s now worth only $7,000. She could sell those holdings and take a $3,000 loss. Then, she could use the proceeds to buy shares of ZYY stock (a similar but not substantially identical stock) after determining that it’s as good as or better than XYZ, given her overall investment goals and objectives.

Sofia could use the $3,000 capital loss from XYZ to reduce her taxable income for the current year. If her combined marginal tax rate is 30%, she could receive a current income tax benefit of up to $900 ($3,000 × 30%). She could then turn around and invest her tax savings back in the market. If she assumes an average annual return of 6%, reinvesting $900 each year could potentially amount to approximately $35,000 after 20 years.

Harvesting losses regularly and proactively—when you rebalance your portfolio, for instance— can save you money over the long run, effectively boosting your after-tax return.

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Where’s Your Refund? Veteran Taxpayer Advocate Offers Tips On Dealing With The Mess At The IRS

The Internal Revenue Service entered this tax filing season severely backlogged and shorthanded—the result of decades of underfunding exacerbated by Covid-19 related strains. As of early last month, the agency had 23.5 million tax returns and pieces of correspondence awaiting manual processing, including some paper returns filed as far back as April of 2021.

Last filing season, 160 million of 195 million taxpayer calls to the IRS didn’t even get through; only 11 million callers got to talk with an IRS employee while another 24 million callers got automated answers.

Nina E. Olson, a tax lawyer and the founder and executive director of the Center for Taxpayer Rights, describes the current problems at the IRS as the worst she’s ever seen. And she’s seen a lot. From 2001 to 2019, she served as the IRS’ National Taxpayer Advocate—an independent voice within the agency charged with helping individual taxpayers and making recommendations to Congress for change.

Before that, she spent years representing clients and running a clinic for low-income taxpayers. The only thing that comes close to the current mess, Olson says, was 1985, when workers at tax return processing centers were struggling with a then new computer system (which is still in use) and fell so far behind that a few famously resorted to hiding returns in closets and in trash bags.

“That was the worst to date. And I think this filing season and the last filing season have really shown that it’s just far worse (now),’’ she said last week during a conversation for Forbes subscribers.

The good news is that the IRS’ problems won’t affect the majority of taxpayers—they can still file their 2021 1040s electronically and see their expected tax refunds appear in their bank accounts within a few weeks. (As of March 4th, the IRS had issued 38 million tax refunds averaging $3,401 each.)

But tens of millions of other Americans won’t be so lucky. The IRS itself has projected that nearly 21 million electronically filed returns could be delayed this tax season because of discrepancies related to changes Congress made in the refundable child and dependent care credits.

That’s on top of millions of other returns that will get kicked out of the IRS’ normal computer processing stream for some other reason—say, a suspected case of identity theft or fraud, a Social Security number that doesn’t match its records or a mismatch related to the 2021 $1,400 per person Economic Impact Payments i.e. stimulus checks.

Olson’s advice is built on her deep understanding of what information is and isn’t available from the IRS and where the worst bottlenecks are—mainly in the agency’s handling of paper, which suffered from Covid-19 shutdowns and restrictions and in the human intensive “error resolution process” which was been overwhelmed by all the Covid relief Congress doled out through the tax code. “Throughout all of 2021, it just never got caught up,’’ Olson says.

What information can’t you get from the IRS? Consider its much advertised “Where’s My Refund?” app. That service can tell you that your return was received, or your refund was approved or that a refund has been sent.

But it won’t tell you anything useful between the received and approved phase, Olson warns. It won’t, for example, tell you that your return was kicked out of normal processing for some discrepancy. (That could be why a pitiful 24% of “Where’s My Refund” users who took a survey last year found it helpful—down from 51% in 2019.)

Here’s another piece of Olson advice that’s particularly relevant this season. Back in December and January, the IRS sent a “2021 Total Advance Child Tax Credit (AdvCTC) Payments” statement—also known as a 6419 letter—telling families with children how much in advance 2021 child tax credits the IRS had paid them. (The payments, made monthly in July through December, were supposed to come to half of the benefits due.)

What if the IRS number is more than what’s shown in your own records—which could well be the case if, for example, you changed your bank account or moved late last year and the money the IRS thinks you got didn’t actually reach you? The IRS recommends you check online to see if it has a more updated number. And if the numbers still don’t match?

Olson recommends you file your return electronically using what you believe is the correct number. True, your refund will get kicked out of the normal processing stream and go into the error resolution system. And true, last year returns waited an average of 75 days in error resolution purgatory to even be assigned to a human being to work.

But the IRS has supposedly programmed its computers to automatically adjust more returns with discrepancies related to stimulus checks and child credits, so the delay shouldn’t be so long this year, Olson says. A key and little understood point, she adds, is you’ll get a refund from the IRS for the lesser amount it thinks you’re due, and eventually receive a “math or clerical” error notice from the IRS explaining why it has reduced your refund.

Why not send in a paper return with an explanation of why your numbers may be different than the ones the IRS has? “Who knows when a paper return is going to be processed?’’ she answers. And then, she adds, when it finally is processed, “probably what will happen is you’ll get a math error adjustment eventually on the paper return, they won’t have looked at your additional information you sent in, and you’ll have to send it in again.”

By filing electronically, she explains, you’ll get the part of your refund the IRS agrees with faster, and you’ll also get your chance to dispute the IRS faster.

About those math error notices—they’re really not about a mistake in calculation in most cases. What they are is the IRS using statutory authority Congress has given it to adjust the numbers on your return, without an audit and without contacting you first. The IRS might reduce your refund, say you owe more, or (if you’re lucky) give you a bigger refund.

If you disagree, it’s crucial you respond within 60 days asking the IRS to abate the change, Olson says. (She suggests you send your objections and any documentation supporting your case by certified mail, which provides you with a mailing receipt to prove you did this in a timely fashion.) Given the IRS’ own delays—no guarantee it will open your letter quickly—was is the 60 days important?

As Olson’s organization explains in a fact sheet, If you miss the 60-day deadline, you can still call or mail information to the IRS showing why you believe it is wrong. But you’ll lose the right to go to the U.S. Tax Court if the IRS continues to disagree with you, and if the IRS says you owe more money, it may begin trying to collect the tax due while it is still reviewing your documentation.

But who wants to hire a tax lawyer and go to court? You can file your suit in the U.S. Tax Court without a lawyer (there are instructions on the Tax Court web site for doing so), and without paying any disputed amount first, answers Olson. And if you do file a suit, your case will get kicked to an appeals officer at the IRS. “Tax Court is actually one way to get to that live human being,’’ she explains.

Speaking of live human beings—“I hate to say this,’’ Olson observes, but there are times when you should actually (deep breath) call the IRS. The IRS projects it will answer 35% of calls this season—an improvement but still not great. The point is there are times when reaching a human at the IRS can make a huge difference. For example, if the math error relates to a mistake your made when you entered a Social Security number, a human agent may be able to fix that with you over the phone, Olson says.

Or, if it’s a case of suspected identity theft, you may be able to establish you are the legitimate taxpayer over the phone, without having to wait for an appointment at an IRS office. In addition, if your refund has been delayed, but you haven’t gotten a math error notice yet, an agent may be able to tell you what the issue is and maybe help you fix it. (That depends on where your return is in the process.)

What about getting help from Olson’s old domain—the Taxpayer Advocate Service? Olson disagrees with a decision last November by current National Taxpayer Advocate Erin M. Collins to reject cases where the sole issue is the delay in the processing of an original or amended tax return—Collins took that action on the grounds that TAS itself was overwhelmed and that delays at the IRS were so severe that the IRS couldn’t give priority to some returns without slowing down processing of others.

Under pressure from members of Congress, who referred 66,000 cases to TAS last year, six times the annual number before the pandemic, TAS is now taking some cases involving processing delays of amended returns—particularly those, for example, involving employers’ quarterly payroll tax returns claiming the Covid-era Employee Retention Credit.

Olson recommends that if a delay at the IRS is causing you financial hardship you both contact your member of Congress and call TAS or fax in a request for TAS assistance (on a Form 911 and yes, the IRS still uses fax machines). There are some issues where TAS is definitely ready to help. For example, if you haven’t gotten your refund because you are the victim of identity theft, TAS will help you get an appointment to get it resolved.

“You’ve got to press on every single lever,’’ says Olson. “I really personally think you should be going to TAS and making them take your case. And I personally think you should go to the members of Congress.” Some constituent cases Congress sends to TAS do get help, she says, and members of Congress “can use that information to force change on a systemic level.”

She points out that the just signed new omnibus spending bill gives the IRS more money for taxpayer service (including $75 million taken from its enforcement budget to process backlogged returns). It also grants the IRS authority to speed up hiring of 10,000 new employees—if it can find them. That, of course, won’t be much help to taxpayers waiting now for their delayed refunds and getting no satisfaction from the “Where’s My Refund?” app.

The video of Olson’s conversation with Forbes is available to subscribers here.

I’m the Washington D.C. bureau chief and an assistant managing editor of Forbes. During my three decades with Forbes, I’ve reported extensively on taxes — tax

Source: Where’s Your Refund? Veteran Taxpayer Advocate Offers Tips On Dealing With The Mess At The IRS

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Critics:

By: Garrett Watson

Taxpayers and the Internal Revenue Service (IRS) are set to face a bumpy 2022 tax filing season, which the IRS announced will begin January 24th and run through April 18th. Two major challenges await taxpayers: a second year of navigating pandemic-related tax relief on their returns and IRS backlogs that may delay processing and refunds.

Over the past two years the IRS has dealt with such challenges as pandemic-related disruptions for staff and the need to quickly administer several large and complicated relief packages enacted through the tax code. The implementation issues at the IRS have exposed the trade-offs of using the tax code to administer social support, especially during the pandemic.

The American Rescue Plan Act (ARPA), passed in March 2021, provided pandemic-related aid to taxpayers through the tax code that can be claimed during the tax season and may affect the size of tax refunds for some taxpayers.

For tax year 2021 only, the ARPA expanded the value of the child tax credit (CTC) from $2,000 per child up to $3,600 for younger children or $3,000 for older children. It also eliminated the earnings requirement and work-related phase-in, expanding the number of households eligible for the credit.

Tax refunds will be impacted by the expanded CTC. Whether they raise or lower individual refund amounts compared to the past depends on individual circumstances, such as the advanced monthly payments last year that were worth up to half of the benefit.

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IRS Temporarily Halts These 10 Scary Taxpayer Letters

Internal Revenue Service computers keep spitting out perplexing letters and notices to taxpayers, and today the agency announced that it’s going to stop the machines, at least temporarily, in an effort to help taxpayers and tax pros. The 2022 tax season kicked off on January 24 for filing 2021 tax year returns, but millions of taxpayers are still waiting for the IRS to process last year’s returns.

Example: You filed your 2020 tax return last April. The IRS cashed your check. Why are you getting an alarming CP-80 Unfiled Tax Return notice that says: “We haven’t received your tax return. What must you do immediately? If you’re required to file, please file today. If you’ve already filed, please send a newly-signed copy.”

Savvy tax pros know that the IRS is woefully backlogged, and the best response is to wait it out. A California tax preparer who filed on paper with a check attached last April emailed me that he got a CP-80 notice last month. The IRS cashed the check, but hasn’t gotten to his return—10 months later.

His plan: “IRS thinks I have overpaid; I can wait 6 months to see if they catch up on paper.” In the meantime, the IRS has updated its web site, Understanding Your CP80 Notice, to tell folks who are getting CP-80 Notices who have already filed their 2020 returns: “DO NOT refile.”

That’s all the IRS needs—more paper! As of the February 7 update to the IRS Operations page, the IRS has made some progress on whittling down the number of amended tax returns for tax year 2020 in processing (2.3 million as of January 8), but it hadn’t updated the number of outstanding individual returns for 2020 (6 million as of December 31).

“The IRS is opening mail within normal timeframes and all paper and electronic individual refund returns received prior (emphasis added) to April 2021 have been processed if the return had no errors or did not require further review.”

That backlog is causing problems down the line. Hence, the decision — after outcry from tax professionals and members of Congress — to stop sending some taxpayer notices and letters for now.

The IRS announcement notes that these automatic notices have been temporarily stopped until the backlog is worked through, and that the agency will continue to assess the inventory of prior year returns to determine the appropriate time to resume the notices. Some taxpayers might still get these notices and letters in the next few weeks. “Generally, there is no need to call or respond.” But watch out: If you believe a notice is accurate and you have a balance due, the IRS says that interest and penalties can continue to accrue.

Here’s the rundown of suspended notices and letters:

CP-80 Unfiled Tax Return(s) 1st Notice: This notice is generally sent when the IRS credited payments and/or other credits to a taxpayer’s account for the tax period shown on the notice, but the IRS hasn’t received a tax return for that tax period.

CP-59 and CP 758 (Spanish version): The IRS sends this notice when there is no record of a prior year return being filed.

CP-516 and CP-616 (Spanish) Unfiled Tax Return(s) – 2nd Notice: This notice is a request for information on a delinquent return as there is no record of a return filed.

CP518 and CP618 (Spanish) Final Notice -Return Delinquency: This is a final reminder notice that the IRS still has no record of a prior year tax return(s)

CP-501 Balance Due — 1st Notice: This notice is a reminder that there is an outstanding balance on a taxpayer’s accounts.

CP-503 Balance Due — 2nd Notice: This notice is the second reminder that a there is an outstanding balance on a taxpayer’s accounts.

CP-504 Final Balance Due Notice/3rd Notice/Intent to Levy: The IRS sends this notice when a payment has not been received for an unpaid balance. This notice is a Notice of Intent to Levy (Internal Revenue Code Section 6331 (d)).

2802C Withholding Compliance Letter: This letter is mailed to taxpayers who have been identified as having under-withholding of Federal tax from their wages. This letter provides instructions to the taxpayer on how to properly correct their tax withholding.

Two business notices are also being temporarily paused.

CP259 and CP959 (Spanish) Return Delinquency: IRS sends this notice when there is no record of a prior year return being filed.

CP518 and CP618 (Spanish) Final Notice -Return Delinquency: This is a final reminder notice that the IRS still has no record of a prior year tax return(s)

A coalition of taxpayer professionals, the Tax Professionals United for Taxpayer Relief Coalition, including the AICPA and H&R Block, is calling for more. They’ve asked the IRS to pause all automated compliance actions and provide relief from underpayment and late payment penalties. Stay tuned.

Follow me on Twitter or LinkedIn.

I cover personal finance, with a focus on retirement planning, trusts and estates strategies, and taxwise charitable giving. I’ve written for Forbes since 1997. Follow me on Twitter: @ashleaebeling and contact me by email: ashleaebeling — at — gmail — dot — com

Source: IRS Temporarily Halts These 10 Scary Taxpayer Letters

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“Total tax revenues”. Our World in Data. Retrieved 7 March 2020.

“Taxation”. Britannica. Retrieved 3 March 2015.

About compliance checks, CC/FS1a, accessed 31 January 2022

Taxes for Revenue are Obsolete” (PDF). American Affairs. VIII (1). Archived from the original (PDF) on 14 March 2017.

“Definition of Taxes (Note by the Chairman), 1996” (PDF). Retrieved 22 January 2013.

Social Security Programs Throughout the World on the U.S. Social Security website for links to individual country program descriptions”. Ssa.gov. Retrieved 22 January 2013.

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corporate tax.

Land Value Taxation: An Applied Analysis. Ashgate Publishing, Ltd. p. 4. ISBN 978-0-7546-1490-6.

“TPC Tax Topics | Federal Budget”. Taxpolicycenter.org. Retrieved 27 March 2009.

The Annotated Constitution of the Australian Commonwealth

Taxes in the Ancient World, University of Pennsylvania Almanac, Vol. 48, No. 28, 2 April 2002

A World History of Tax Rebellions. Taylor & Francis. pp. vi–viii. ISBN 9780415924986.

The Rig-Vedic and Post-Rig-Vedic Polity (1500 BCE-500 BCE). Vernon Press. ISBN 978-1-64889-001-7.

Ancient tax collectors amassed a fortune — until it went up in smoke”. Nature. 14 September 2020.

History of the World in 100 Objects:Rosetta Stone”

Treasury Reconsiders IRS’ Use of Facial Recognition Company ID.me

The Treasury Department is reassessing the Internal Revenue Service’s use of third-party facial recognition software ID.me for access to taxpayer accounts amid growing concerns about the company’s privacy practices. A department official told FOX Business on Friday that Treasury and the IRS are exploring alternatives to ID.me. Bloomberg first reported the news.

“The IRS is consistently looking for ways to make the filing process more secure,” spokeswoman Alexandra LaManna said in a statement to FOX Business. “But to be clear, no American is required to take a selfie in order to file their tax return.”

The IRS had previously announced that beginning in summer 2022, users who need to log on to the agency’s website to access the Child Tax Credit Update Portal, check online accounts, get their tax transcript, receive an Identity Protection PIN or view an online payment agreement will need to create an account with identity verification company ID.me.

Existing online accounts, which currently only require a simple email and password to access, will no longer work beginning this summer, the IRS said. At that point, users will be required to create an account with ID.me.

The Internal Revenue Service (IRS) headquarters building in Washington.  (AP Photo/J. David Ake, File / AP Newsroom)

The IRS has stressed that individuals will not actually be required to go through ID.me or use facial-recognition software to submit their tax returns. But taxpayers will still be forced to use this software in order to take advantage of some of the IRS’ most basic tools. The agency is already urging taxpayers to create accounts “as soon as possible.”

“The IRS emphasizes taxpayers can pay or file their taxes without submitting a selfie or other information to a third-party identity verification company,” the agency said in a statement. “Tax payments can be made from a bank account, by credit card or by other means without the use of facial recognition technology or registering for an account.”

ID.me describes itself as a technology provider that offers secure identity verification by comparing a photo ID provided by users with a video selfie. It was launched in 2010 by military veteran Blake Hall and has quickly solidified its place in the identity-verification business, often on behalf of the U.S. government. Additional IRS tools will begin using ID.me verification “over the next year,” the IRS said.

Users must provide ID.me with an email address, Social Security number, photo ID and take a selfie with a camera that will scan the user’s face to verify their identity.

But the company drew fresh scrutiny this week when CEO Blake Hall admitted in a LinkedIn post that ID.me uses Amazon’s Recognition technology to compare video selfies submitted by users to its own, bigger internal database of previous applicants. Hall had previously claimed the company used so-called one-to-one technology, a process that compares a selfie taken by an individual to an official document like a driver’s license.

“I apologize for that,” Hall told Axios on Wednesday. “My intent is never to mislead.” LaManna noted that ID.me is compliant with the National Institute of Standards and Technology. The software is also used by multiple agencies across the government. 

Still, the news prompted an immediate outcry from privacy advocates, who have warned the practice is invasive and that the IRS is opening the doors to potential data breaches.

The decision “will only lead to further ruin for Americans when their data is inevitably breached,” Jackie Singh, director of technology and operations at the Surveillance Technology Oversight Project, wrote on Twitter. She called the practice “very bad,” and called on every “tech-aware American to fight it.”

Source: Treasury reconsiders IRS’ use of facial recognition company ID.me | Fox Business

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Do You Have To Pay Capital Gains Tax On a Home Sale?

Your home is likely your life’s biggest and proudest purchase: all the painstaking measures you took—countless property searches, contract negotiations, inspections, and closing—to arrive at the dream of homeownership. Now, it’s time to sell. What next?pr

Did you know that your home is considered a capital asset, subject to capital gains tax? If your home has appreciated in value, you could be required to pay taxes on the profit.

However, thanks to the Taxpayer Relief Act of 1997, most homeowners are exempt. If you are single, you will pay no capital gains tax on the first $250,000 of profit (excess over cost basis). Married couples enjoy a $500,000 exemption. There are, however, some restrictions.

Key Takeaways

You can sell your primary residence and be exempt from capital gains taxes on the first $250,000 if you are single and $500,000 if married filing jointly. This exemption is only allowable once every two years.

You can add your cost basis and costs of any improvements that you made to the home to the $250,000 if single or $500,000 if married filing jointly. How Much Is Capital Gains Tax on Real Estate? To be exempt, the home must be considered a primary residency based on Internal Revenue Service (IRS) rules. These rules state that you must have occupied the residence for at least two of the last five years.

If you buy a home and a dramatic rise in value causes you to sell it a year later, you would be required to pay capital gains tax. If you’ve owned your home for at least two years and meet the primary residence rules, you may owe tax on the profit if it exceeds IRS thresholds. Single people can exclude up to $250,000 of the gain, and married people filing a joint return can exclude up to $500,000 of the gain.

Short-term capital gains are taxed as ordinary income, with rates as high as 37% for high-income earners; long-term capital gains tax rates are 0%, 15%, 20%, or 28%, with rates applied according to income and tax filing status.

This rule even allows you to convert a rental property into a primary residence, because the two-year residency requirement does not need to be fulfilled in consecutive years. The 2-in-5-year rule For taxpayers with more than one home, a key point is determining which is the primary residence.

The IRS allows the exclusion on only one’s primary residence, but there is some leeway in just which home qualifies. The two-in-five-year rule comes into play. Simply put, this means that during the previous five years, if you lived in a home for a total of two years, or 730 days, that can qualify as your primary residence. The 24 months do not have to be in a particular block of time. However, for married taxpayers filing jointly, each spouse must meet the rule.

How the Capital Gains Tax Works with Homes

Suppose you purchase a new condo for $300,000. You live in it for the first year, rent the home for the next three years, and when the tenants move out, you move in for another year. After five years, you sell the condo for $450,000. No capital gains tax is due because the profit ($450,000 – $300,000 = $150,000) does not exceed the exclusion amount. Consider an alternative ending in which home values in your area increased exponentially.

In this scenario, you sell the condo for $600,000. Capital gains tax is due on $50,000 ($300,000 profit – $250,000 IRS exclusion). If your income falls in the $40,400–$441,450 range, your capital gains tax rate as a single person is 15% in 2021.5 (The income range rises slightly, to the $41,675–$459,750 range, for 2022.)6 If you have capital losses elsewhere, you can offset the capital gains from the sale of the house by those losses, and up to $3,000 of those losses from other taxable income.

2022 Long-term Capital Gains Rates
Filing Status 0% Tax Rate 15% Tax Rate 20% Tax Rate
Single < $41,675 $41,675 to $459,750 > $459,750
Married filing jointly < $83,350 $83,350 to $517,200 > $517,200
Married filing separately < $41,675 $41,675 to $258,600 > $258,600
Head of household < $55,800 $55,800 to $488,500 > $488,500

Applicable to the Sale of a Principal Residence

2022 Long-term Capital Gains Rates
Filing Status 0% Tax Rate 15% Tax Rate 20% Tax Rate
Single < $41,675 $41,675 to $459,750 > $459,750
Married filing jointly < $83,350 $83,350 to $517,200 > $517,200
Married filing separately < $41,675 $41,675 to $258,600 > $258,600
Head of household < $55,800 $55,800 to $488,500 > $488,500

Applicable to the Sale of a Principal Residence Requirements and Restrictions If you meet the eligibility requirements of the IRS, you’ll be able to sell the home free of capital gains tax. However, there are exceptions to the eligibility requirements, which are outlined on the IRS website.The main major restriction is that you can only benefit from this exemption once every two years. Therefore, if you have two homes and lived in both for at least two of the last five years, you won’t be able to sell both of them tax free.

The Taxpayer Relief Act of 1997 significantly changed the implications of home sales in a beneficial way for homeowners. Before the act, sellers had to roll the full value of a home sale into another home within two years to avoid paying capital gains tax. However, this is no longer the case, and the proceeds of the sale can be used in any way that the seller sees fit. When Is a Home Sale Fully Taxable? Not everyone can take advantage of the capital gains exclusions. Gains from a home sale are fully taxable when:

  • The home is not the seller’s principal residence
  • The property was acquired through a 1031 exchange (more on that below) within five years
  • The seller is subject to expatriate taxes
  • The property was not owned and used as the seller’s principal residence for at least two of the last five years prior to the sale (some exceptions apply)
  • The seller sold another home within two years from the date of the sale and used the capital gains exclusion for that sale

Example of Capital Gains Tax on a Home Sale Consider the following example: Susan and Robert, a married couple, purchased a home for $500,000 in 2015. Their neighborhood experienced tremendous growth, and home values increased significantly. Seeing an opportunity to reap the rewards of this surge in home prices, they sold their home in 2020 for $1.2 million. The capital gains from the sale were $700,000.As a married couple filing jointly, they were able to exclude $500,000 of the capital gains, leaving $200,000 subject to capital gains tax. Their combined income places them in the 20% tax bracket. Therefore, their capital gains tax was $40,000.

How to Avoid Capital Gains Tax on Home Sales Want to lower the tax bill on the sale of your home? There are ways to reduce what you owe or avoid taxes on the sale of your property. If you own and have lived in your home for two of the last five years, you can exclude up to $250,000 ($500,000 for married people filing jointly) of the gain from taxes.

Adjustments to the cost basis can also help reduce the gain. Your cost basis can be increased by including fees and expenses associated with the purchase of the home, home improvements, and additions. The resulting increase in the cost basis thereby reduces the capital gains.Also, capital losses from other investments can be used to offset the capital gains from the sale of your home. Large losses can even be carried forward to subsequent tax years.

Let’s explore other ways to reduce or avoid capital gains taxes on home sales. Use 1031 Exchanges to Avoid Taxes Homeowners can avoid paying taxes on the sale of their home by reinvesting the proceeds from the sale into a similar property through a 1031 exchange. This like-for-like exchange—named after Internal Revenue Code Section 1031—allows for the exchange of like property with no other consideration or like property including other considerations, such as cash.

The 1031 exchange allows for the tax on the gain from the sale of a property to be deferred, rather than eliminated.Owners—including corporations, individuals, trust, partnerships, and limited liability companies (LLCs)—of investment and business properties can take advantage of the 1031 exchange when exchanging business or investment properties for those of like kind.The properties subject to the 1031 exchange must be for business or investment purposes, not for personal use.

The party to the 1031 exchange must identify in writing replacement properties within 45 days from the sale and must complete the exchange for a property comparable to that in the notice within 180 days from the sale.9Since executing a 1031 exchange can be a complex process, there are advantages to working with a reputable, full-service 1031 exchange company.

Given their scale, these services generally cost less than attorneys who charge by the hour. A firm that has an established track record in working with these transactions can help you avoid costly missteps and ensure that your 1031 exchange meets the requirements of the tax code. Convert Your Second Home into Your Primary Residence Capital gains exclusions are attractive to many homeowners, so much so that they may try to maximize its use throughout their lifetime.

Because gains on non-primary residences and rental properties do not have the same exclusions, more people have sought clever ways to reduce their capital gains tax on the sale of their properties. One way to accomplish this is to convert a second home or rental property to a primary residence.

A homeowner can make their second home as their primary residence for two years before selling and take advantage of the IRS capital gains tax exclusion. However, stipulations apply. Deductions for depreciation on gains earned prior to May 6, 1997, will not be considered in the exclusion.10According to the Housing Assistance Tax Act of 2008, a rental property converted to a primary residence can only have the capital gains exclusion during the term in which the property was used as a principal residence.

The capital gains are allocated to the entire period of ownership. While serving as a rental property, the allocated portion falls under non-qualifying use and is not eligible for the exclusion.10To prevent someone from taking advantage of the 1031 exchange and capital gains exclusion, the American Jobs Creation Act of 2004 stipulates that the exclusion applies if the exchanged property had been held for at least five years after the exchange.12An IRS memo explains how the sale of a second home could be shielded from the full capital gains tax, but the hurdles are high.

It would have to be investment property exchanged for another investment property. The taxpayer has to have owned the property for two full years, it has to have been rented to someone for a fair rental rate for at least 14 days in each of the previous two years, and it cannot have been used for personal use for 14 days or 10 percent of the time it was otherwise rented, whichever is greater for the previous 12 months.In short, if it’s a vacation home, it’s not your primary residence and it’s not an investment property, then its sale is subject to capital gains taxes.

How Installment Sales Lower Taxes Realizing a large profit at the sale of an investment is the dream. However, the corresponding tax on the sale may not be. For owners of rental properties and second homes, there is a way to reduce the tax impact. To reduce taxable income, the property owner might choose an installment sale option, in which part of the gain is deferred over time. A specific payment is generated over the term specified in the contract.

Each payment consists of principal, gain, and interest, with the principal representing the nontaxable cost basis and interest taxed as ordinary income. The fractional portion of the gain will result in a lower tax than the tax on a lump-sum return of gain. How long the property owner held the property will determine how it’s taxed: long-term or short-term capital gains.
How Real Estate Taxes Work Taxes for most purchases are assessed on the price of the item being bought.

The same is true for real estate. State and local governments levy real estate or property taxes on real properties; these collected taxes help pay for public services, projects, schools, and more.Real estate taxes are ad valorem taxes, which are taxes assessed against the value of the home and the land it sits on. It is not assessed on the cost basis—what was paid for it. The real estate tax is calculated by multiplying the tax rate by the assessed value of the property. Tax rates vary across jurisdictions and can change, as can the assessed value of the property. However, some exemptions and deductions are available for certain situations.

How to Calculate the Cost Basis of a Home The cost basis of a home is what you paid (your cost) for it. Included are the purchase price, certain expenses associated with the home purchase, improvement costs, certain legal fees, and more.Example: In 2010, Rachel purchased her home for $400,000. She made no improvements and incurred no losses for the 10 years that she lived there. In 2020, she sold her home for $550,000.

Her cost basis was $400,000, and her taxable gain was $150,000. She elected to exclude the capital gains and, as a result, owed no taxes. What Is Adjusted Home Basis? The cost basis of a home can change. Reductions in cost basis occur when you receive a return of your cost. For example, you purchased a house for $250,000 and later experienced a loss from a fire. Your home insurer issues a payment of $100,000, reducing your cost basis to $150,000 ($250,000 original cost basis – $100,000 insurance payment).

Improvements that are necessary to maintain the home with no added value, have a useful life of less than one year, or are no longer part of your home will not increase your cost basis.

Likewise, some events and activities can increase the cost basis. For example, you spend $15,000 to add a bathroom to your home. Your new cost basis will increase by the amount that you spent to improve your home. Basis When Inheriting a Home If you inherit a home, the cost basis is the fair market value (FMV) of the property when the original owner died.15 For example, say you are bequeathed a house for which the original owner paid $50,000. The home was valued at $400,000 at the time of the original owner’s death. Six months later, you sell the home for $500,000.

The taxable gain is $100,000 ($500,000 sales price – $400,000 cost basis).The FMV is determined on the date of the death of the grantor or on the alternate valuation date if the executor files an estate tax return and elects that method.16 Reporting Home Sale Proceeds to the IRS It is required to report the sale of a home if you received a Form 1099-S reporting the proceeds from the sale or if there is a non-excludable gain.

Form 1099-S is an IRS tax form reporting the sale or exchange of real estate. This form is usually issued by the real estate agency, closing company, or mortgagee. If you meet the IRS qualifications for not paying capital gains tax on the sale, inform your real estate professional by Feb. 15 following the year of the transaction.

The IRS details what transactions are not reportable:

  • If the sales price is $250,000 ($500,000 for married people) or less and the gain is fully excludable from gross income. The homeowner must also affirm that they meet the principal residence requirement. The real estate professional must receive certification that these attestations are true.
  • If the transferor is a corporation, a government or government sector, or an exempt volume transferor (someone who has or will sell 25 or more reportable real estate properties to 25 or more parties)
  • Non-sales, such as gifts
  • A transaction to satisfy a collateralized loan
  • If the total consideration for the transaction is $600 or less, which is called a de minimus transfer

Special Considerations What happens in the event of a divorce or for military personnel? Fortunately, there are considerations for these situations. In a divorce, the spouse granted ownership of a home can count the years that the home was owned by the former spouse to qualify for the use requirement.3 Also, if the grantee has ownership in the house, the use requirement can include the time that the former spouse spends living in the home until the date of sale.

Military personnel and certain government officials on official extended duty and their spouses can choose to defer the five-year requirement for up to 10 years while on duty. Essentially, as long as the military member occupies the home for two out of 15 years, they qualify for the capital gains exclusion (up to $250,000 for single taxpayers and up to $500,000 for married taxpayers filing jointly).

Capital Gains Taxes on Investment Property Real estate can be categorized differently. Most commonly, it is categorized as investment or rental property or principal residences. An owner’s principal residence is the real estate used as the primary location in which they live. An investment or rental property is real estate purchased or repurposed to generate income or a profit to the owner(s) or investor(s).

How the property is classified affects how it’s taxed and what tax deductions, such as mortgage interest deductions, can be claimed. Under the Tax Cuts and Jobs Act of 2017, up to $750,000 of mortgage interest on a principal residence can be deducted. However, if a property is solely used as an investment property, it does not qualify for the capital gains exclusion.

Deferrals of capital gains tax are allowed for investment properties under the 1031 exchange if the proceeds from the sale are used to purchase a like-kind investment. And capital losses incurred in the tax year can be used to offset capital gains from the sale of investment properties. So, although not afforded the capital gains exclusion, there are ways to reduce or eliminate taxes on capital gains for investment properties.

Rental Property vs. Vacation Home Rental properties are real estate rented to others to generate income or profits. A vacation home is real estate used recreationally and not considered the principal residence. It is used for short-term stays, primarily for vacations.Homeowners often convert their vacation homes to rental properties when not in use by them. The income generated from the rental can cover the mortgage and other maintenance expenses. However, there are a few things to keep in mind.

If the vacation home is rented out for less than 15 days, the income is not reportable. If the vacation home is used by the homeowner for less than two weeks in a year and then rented out for the remainder, it is considered an investment property.Homeowners can take advantage of the capital gains tax exclusion when selling their vacation home if they meet the IRS ownership and use rules.

Real Estate Taxes vs. Property Taxes The terms real estate and property are often used interchangeably, as are real estate taxes and property taxes. However, property is actually a broad term used to describe different assets, including real estate, owned by a person; also, not all property is taxed the same.Property taxes, as they relate to real estate, are ad valorem taxes assessed by the state and local governments where the real property is located.

The real estate property tax is calculated by multiplying the property tax rate by real property’s market value, which includes the value of the real property (e.g., houses, condos, and buildings) and the land that it sits on.

Property taxes, as they relate to personal property, are taxes applied to movable property. Real estate, which is immovable, is not included in personal property tax. Examples of personal property include cars, watercraft, and heavy equipment. Property taxes are applied at the state or local level and may vary by state.

Are Home Sales Tax Free?

Yes. Home sales are tax free as long as the condition of the sale meets certain criteria:

  • The seller must have owned the home and used it as their principal residence for two out of the last five years (up to the date of closing). The two years do not have to be consecutive to qualify.
  • The seller must not have sold a home in the last two years and claimed the capital gains tax exclusion.
  • If the gains do not exceed the exclusion threshold ($250,000 for single people and $500,000 for married people filing jointly), the seller does not owe taxes on the sale of their house.1

How Do I Avoid Paying Taxes When I Sell My House?

There are several ways to avoid paying taxes on the sale of your house. Here are a few:

  • Offset your capital gains with capital losses. Capital losses from previous years can be carried forward to offset gains in future years.
  • Consider using the IRS primary residence exclusion. For single taxpayers, you may exclude up to $250,000 of the capital gains, and for married taxpayers filing jointly, you may exclude up to $500,000 of the capital gains (certain restrictions apply).
  • Also, under a 1031 exchange, you can roll the proceeds from the sale of a rental or investment property into a like investment within 180 days.

How Much Tax Do I Pay When Selling My House?

How much tax you pay is dependent on the amount of the gain from selling your house and on your tax bracket. If your profits do not exceed the exclusion amount and you meet the IRS guidelines for claiming the exclusion, you owe nothing. If your profits exceed the exclusion amount and you earn from $40,400 to $441,450, you will owe a 15% tax (based on the single filing status) on the profits.5

Do I Have to Report the Sale of My Home to the IRS?

It is possible that you are not required to report the sale of your home if none of the following is true:

  • You have non-excludable, taxable gain from the sale of your home (less than $250,000 for single taxpayers and less than $500,000 for married taxpayers filing jointly).
  • You were issued a Form 1099-S, reporting proceeds from real estate transactions.
  • You want to report the gain as taxable, even if all or a portion falls within the exclusionary guidelines.

What is the Penalty for Selling a House Less Than Two Years After Purchase?

You probably cannot qualify for the $250,000/$500,000 exemption from gains on selling your primary residence. That’s because to qualify for that exemption, you must have used the home in question as your primary residence for at least two of the previous five years, and you generally can’t use the exemption twice within two years.However, there are exceptions for certain circumstances: Military service, death of a spouse, and job relocation are the most common reasons that might allow you to take at least a partial exemption. The IRS has a worksheet for determining an exclusion limit; see Topic 701.

Do You Pay Capital Gains Taxes When You Sell a Second Home?

Because the IRS allows exemptions from capital gains taxes only on a primary residence, it’s difficult to avoid capital gains taxes on the sale of a second home without converting that home to your primary residence by considering the two-in-five-year rule (you lived in it for a total of two of the past five years). Put simply, you determine that you spent enough time in one home that it is actually your primary residence.If one of the homes was primarily an investment, it’s not set up to be the exemption-eligible home. The demarcation between investment property and vacation property goes like this: It’s investment property if the taxpayer has owned the property for two full years, it has been rented to someone for a fair rental rate for at least 14 days in each of the previous two years, and it cannot have been used for personal use for 14 days or 10 percent of the time that it was otherwise rented, whichever is greater, for the previous 12 months.If you or your family use it for more than two weeks a year, it’s likely to be considered personal property, not investment property, and thus subject to taxes on capital gains, as would any other asset other than your principal residence.

What If You Sell a House Less Than Two Years After Buying It?

You probably cannot qualify for the $250,000 single/$500,000 married-filing-jointly exemption from gains on selling your primary residence. That’s because to qualify for that exemption, you must have used the home in question as your primary residence for at least two of the previous five years, and you generally can’t use the exemption twice within two years.However, there are exceptions for certain circumstances: Military service, death of a spouse, and job relocation are the most common reasons that might allow you to take at least a partial exemption. The IRS has a worksheet for determining an exclusion limit; see Topic 701.

Do You Pay Capital Gains If You Lose Money on a Home Sale?

You can’t deduct the losses on a primary residence, nor can you treat it as a capital loss on your taxes. You may be able to do so, however, on investment property or rental property. Keep in mind that gains from the sale of one asset can be offset by losses on other asset sales up to $3,000 or your total net loss, and such losses may be eligible for carryover in subsequent tax years.If you sell below-market to a relative or friend, the transaction may subject the recipient to taxes on the difference, which the IRS may consider a gift.

Also remember that the recipient inherits your cost basis for purposes of determining any capital gains when they sell it, so the recipient should be aware of how much you paid for it, how much you spent on improvement, and costs of selling, if any.

By: Chad Langager

Source: Do You Have to Pay Capital Gains Tax on a Home Sale?

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