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Real Estate Law Changes: Beware the Fiscal Cliff!

Real estate law has changed causing investors to question if pandora's box has been opened

California Real Estate Owners Face Increased Taxes in 2013

Real estate investors beware! The new year sparks more than resolutions. What? You mean there’s more than getting back into the gym. Yep. 2013 marks a change to California’s real estate law.

In our last post, we learned that the fiscal cliff didn’t change the requirement or need to create a living trust to avoid probate. The fiscal cliff may have, however, opened pandora’s box to a new tax scheme as it relates to real estate law that could have dramatic and long-lasting impacts on California real property owners now and in the future as follows.

1.  3.8% medicare tax applies to capital gain on the sale of real estate for individuals with more than $200,000 of income per year (joint filers $250,000/year).

2.  20% capital gains tax applies to individuals more than $400,000 of income per year (joint filers $450,000/year).

    • This is a major leap from 15% tax in 2012.
    • The 20% capital gains applies to income from all sources. While your ordinary income may be low enough to avoid the capital gains tax, gains realized from the sale of real estate may push you over the 20% mark.

3.  25% depreciation recapture tax is still in effect. Nothing has changed here.

4.  Example: California’s new real estate law provides that a sale of real property for $575,000 gain and $100,000 in depreciation incurs the following costs.

    • The 3.8% medicare tax cost is $18,050 ($475,000 x 3.8%).
    • The 20% “fed” capital gains cost is $95,000 ($475,000 x 20%).
    • The 25% depreciation recapture cost is $25,000 ($100,000 x 25%).
    • The total amount of federal tax due is $138,050.
      • The cost is tremendous. Even more upsetting is that the same sale of real estate in 2012 would have cost $96,250 (43% less than the amount owed under the new real estate law rules).

Deferring Taxes Through Real Estate Law

Changes to real estate law causing owners to pay increased taxes in California under Prop 30 Okay we’ve got the Feds figured out. Are there any new California-specific real estate laws or taxes? In short, yes.

Proposition 30 in California increases the state tax rates a considerable amount from 9.6% up to 12.3% depending on income earned (including gains from the sale of real estate). For married couples with incomes over $500,000, the rates are:

  • 10.3% for joint filers with $500,000 – $600,000 income,
  • 11.3% for joint filers with $600,000 – $1 million of income, and
  • 12.3% for couples with over a million of income.

And don’t forget if you’re income is over $400,000, you’ve got to pay the feds a 20% on the capital gains earned too.

The question begs – how do you plan and ultimately pay for these type of events?

One option is to utilize another real estate law called a “1031 Exchange” if you’re selling investment real estate (other than your home) and you wish to continue your investment in real estate. Properly completing a 1031 tax deferred exchange under existing California real estate law will allow you to defer your taxes. This means you won’t have to pay now.

There is additional protection for gains earned on the sale of one’s home. Qualified married couples for instance can exclude up to $500,000 of gain on the sale of their primary residence under existing real estate law.

About Sean Hanley

Practicing law since 2007, Sean specializes in the ever-changing laws related to real estate, business and estate planning. Embracing technology with a focus on personalized service, he understands the challenges of living and thriving in Silicon Valley. Tapping into his education in economics and business administration, Sean also serves on the non-profit Willow Glen Business Association.

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