Ch5. Capital Gains Tax — Taxing Real Estate Dispositions

Capital Gains Tax Overview

Capital gains tax:
Tax on the profit from selling capital assets —
real estate, stocks, securities, and other investment assets.

Taxable disposition types:
- Sale (including installment sales)
- Exchange (like-kind and non-like-kind)
- Involuntary conversion (condemnation, casualty)
- Foreclosure

Holding period classification:
Short-term: Asset held 12 months or less → taxed as ordinary income
Long-term: Asset held more than 12 months → preferential tax rates

Taxable capital assets:
① Real property (land, buildings, rental property)
② Rights to real property (options, easements)
③ Securities (stocks — listed and unlisted)
④ Other capital assets (collectibles, crypto, business property)

Disposition = taxable event only for sales and taxable exchanges
(Gifts transfer the basis, not a taxable event for the donor)

Computing the Capital Gain

Capital Gain Computation:
Amount Realized = Selling price + liabilities assumed by buyer
                  − selling costs (commissions, transfer taxes, fees)

Adjusted Basis:
Original cost (or FMV at date of death for inherited property)
+ Capital improvements (additions, renovations, infrastructure)
− Depreciation previously deducted (for rental/business property)

Capital Gain = Amount Realized − Adjusted Basis

Long-term capital gain after § 121 exclusion:
Amount Realized
  − Adjusted Basis (purchase price + improvements − depreciation)
= Gross Gain
  − § 121 Exclusion (up to $250K/$500K for primary home)
= Taxable Gain

Annual exclusion for individuals:
No annual exclusion analogous to Korea's 2.5M KRW;
use § 121 (home), § 1031 (like-kind exchange), or loss harvesting.

Long-Term Capital Gains Holding Period Deduction

The key break point is holding an asset for more than 12 months.
There is no sliding-scale deduction like the Korean LTBC (long-term
holding special deduction). Instead, the rate drops:

Short-term (≤12 months): ordinary income rates (10%–37%)
Long-term (>12 months): preferential rates

Preferential long-term capital gains rates (2024, single filer):
$0 – $47,025: 0%
$47,026 – $518,900: 15%
Over $518,900: 20%

Unrecaptured § 1250 gain (depreciation on real property): 25%
Collectibles gain: 28%
NIIT (net investment income tax): additional 3.8% above AGI $200K/$250K

Strategy — equivalent to long-term holding deductions:
3+ year holding (0% rate for many taxpayers):
→ For taxpayers with taxable income below $47,025 (single)
   the effective capital gains rate is 0%
→ Hold assets into a lower-income year to access the 0% rate

10+ year holding strategy:
→ Ensure long-term treatment by confirming >12 month holding
→ No graduated sliding scale, but long-term status itself is the key

Section 121 — Primary Residence Sale Exclusion

§ 121 Exclusion Requirements:
① The property must be the taxpayer's principal residence
② Owned for at least 2 of the 5 years preceding the sale
③ Used (lived in) for at least 2 of the 5 years preceding the sale
   (ownership and use periods need not overlap)
④ Not used the exclusion in the prior 2 years

Exclusion amounts:
Single / Married Filing Separately: up to $250,000 of gain excluded
Married Filing Jointly: up to $500,000 of gain excluded

Amount over exclusion: taxed as long-term capital gain

Non-qualifying use (post-2008 rental):
Periods after 12/31/2008 when the home was rented or used for business
reduce the excludable gain proportionately.

Partial exclusion (for sales before meeting full requirements):
If sale is due to job change, health, or unforeseen circumstances,
a prorated exclusion may apply.

Temporary 2-Home Ownership (Equivalent to Korean “Transitional 2-Home” Provision)

US equivalent:
§ 121 exclusion allows a 2-year "ownership and use" lookback period.
During that window, even if you own two homes, the exclusion applies
to the home that qualifies as your principal residence.

Key considerations:
- Only ONE residence can qualify as the "principal residence" at a time
- IRS considers where you vote, receive mail, work, spend most time
- No automatic grace period for buying before selling; must establish
  primary residence facts

Example (transitional situation):
Jan 2022: Buy new home (Home 2)
Jun 2022: Move into Home 2 as principal residence
Dec 2023: Sell Home 1 (bought Jan 2019, lived in until Jun 2022)
→ Home 1: owned 5 years, used as principal residence Jan 2019 – Jun 2022 (3.5 years = ≥2 years)
→ § 121 exclusion applies to Home 1 sale

Tax Rates

Holding period-based rates:
Short-term (≤12 months): 10%–37% (ordinary income brackets)
Long-term (>12 months): 0%, 15%, or 20%

Investment real estate — special rules:
Non-business land: long-term 0%/15%/20%
Rental property with depreciation: Unrecaptured § 1250 gain at 25%

Multi-property owners (equivalent to multi-home surcharge):
No direct US equivalent to Korean multi-home surtax.
Passive activity rules (IRC § 469) and NIIT (3.8%) provide
increased complexity, but no flat surtax based on count of properties.

Non-business property (land, bare plots):
Long-term rate applies (0%/15%/20%)
No special additional rate for land without improvement.

Filing and Payment

Reporting capital gains:
Schedule D (Form 1040): Summary of all capital transactions
Form 8949: Itemized list of each sale (required)

Annual deadline:
April 15 (with Form 1040)

Estimated taxes:
If large gains expected, increase Q3 or Q4 estimated payments
to avoid underpayment penalty.
IRS safe harbor: pay 100% of prior year's tax (or 110% if AGI > $150K)

§ 121 primary home exclusion — 3 requirements ★★★★★ : Principal residence + owned 2 of last 5 years + used (lived in) 2 of last 5 years + no exclusion in prior 2 years. $250K single /$ 500K MFJ. Memory tip: 2+2+5 — 2 years owned, 2 years used, within last 5 years

Long-term holding maximum benefit ★★★★★ : Long-term rate 0% (income under $47K single). No sliding-scale deduction — the rate drop from ordinary → 0%/15%/20% IS the long-term benefit. Memory tip: >12 months = long-term = potentially 0% rate for many taxpayers

Short-term vs. long-term rates ★★★★☆ : Short-term: 10%–37% (same as wages). Long-term: 0%–20% (up to 23.8% with NIIT). Memory tip: Short = ordinary rates (up to 37%); Long = preferential (max 20% + possible 3.8% NIIT)

Practice Quiz

Q. A home was purchased for $300,000 and sold for$ 800,000 after being owned and used as a primary residence for 10 years. The owner is single. What is the taxable gain?

Gross gain = $800K −$ 300K = $500,000. § 121 exclusion =$ 250,000 (single). Taxable gain = $500,000 −$ 250,000 = $250,000, subject to long-term capital gains rates.

Q. If a primary residence is sold only 1 year and 9 months after purchase (due to a job relocation), can any § 121 exclusion be claimed?

Yes — a partial exclusion is available when the sale is due to a change in employment. The exclusion is prorated: 21 months ÷ 24 months = 87.5% of the $250,000 =$ 218,750 excluded (single). The proportional exclusion applies even though the full 2-year requirement wasn’t met.