May 2023 Market Stats with John Barker

TAXES, TAXES AND MORE TAXES, WHAT ARE THEY AND HOW DO THEY AFFECT YOUR REAL ESTATE TRANSACTION?

The Washington State Supreme court recently upheld a new capital gains tax, and it got me thinking about my clients and taxes. I often get questions about real estate taxes because it is a complicated issue involving thousands and thousands of dollars. Here is a breakdown.

There are several taxes that relate to real estate, Capital Gains – both Federal and State, Excise Tax, Property Tax and FIRPTA.

CAPITAL GAINS TAX

There are two types, Federal Capital Gains and now a State Capital Gains Tax. The federal capital gains tax is a tax on the profits made from the sale of assets such as stocks, bonds, and real estate. The tax rate varies depending on how long the asset was held before being sold, with shorter holding periods resulting in higher tax rates. For assets held for less than one year, the tax rate is the same as the taxpayer's ordinary income tax rate. For assets held for more than one year, the tax rate ranges from 0% to 20% depending on the taxpayer's income level. It is important for taxpayers to understand how it works in order to make informed financial decisions.

Although the federal capital gains tax applies against all capital assets, Washington’s new capital gains tax exempts all real property, including real property held in a business. Realized gains of stock or other intangible property are taxed, but land is not.  This might make real estate a more attractive investment vehicle in the years ahead.  State Capital Gains Tax is a new concept that was passed into law in 2021 and was recently upheld by the Washington State Supreme Court. This article below from Holmquist & Gardiner, PLLC, describes the recent court ruling and now it applies and doesn’t apply to real estate transactions. 

Washington’s New Capital Gains Tax: What You Should Know

Author: Grayson Chester, Holmquist & Gardiner Attorneys at Law

     After much tense debate, Washington’s Supreme Court has upheld our state’s new capital gains tax passed by the Washington legislature in 2021 which levies a 7% tax on certain types of realized capital gains over $250,000 each year. Although income taxes have widely been considered unconstitutional in Washington, the Washington Supreme Court has accepted the argument that this is not a tax on income but rather an excise tax on gain—and therefore not subject to Washington’s strict uniformity requirements that have generally frustrated prior attempts to create what feels like an income tax in this state.  This new capital gains tax went into effect January 1, 2022, but was only just now upheld as constitutional under state law after a long fight in court.  With this new tax now in place, we believe our clients should know the following facts about the new state capital gains tax in RCW Chapter 82.87:

Washington’s capital gains tax hits married couples harder than individuals.

     Each individual taxpayer in Washington gets a $250,000 exemption against capital gains. This is meant to roughly mirror the federal exemption of $250,000 per person for capital gains attributable to the sale of a primary residence. Unlike the analogous federal deduction, however, the state does not permit married couples to combine their exemptions—each married couple shares only one exemption. Worse, couples who are married but file separately must split one exemption, even though each as individual single people would have gotten $250,000 apiece. Married couples face higher taxes because they are married.

Washington’s capital gains tax exempts most real estate.

     Although the federal capital gains tax applies against all capital assets, Washington’s new capital gains tax exempts all real property, including real property held in a business. Realized gains of stock or other intangible property is taxed, but land is not. If you thought Washington real estate prices were out of control now, just wait until you see what happens now that Washington has made every parcel of land in our state a tax shelter, no matter its size, purpose, or nature of ownership. If given the choice between owning land or owning public stocks, the tax incentive is obvious: only one of these will be taxed.

This tax is already in effect and filing requirements have already been triggered.

     Despite this tax only being found constitutional in 2023, it was passed in 2021 with the starting date of January 1, 2022.  That date is still the applicable starting date of the new tax, meaning that 2022 is the first year it is in force—not 2023.  This means that realized gain in 2022 may be subject to this tax, even if we did not yet know at that time whether the tax would be found constitutional.  Tax reporting for the 2022 tax year was due April 18, 2023, and the Washington Department of Revenue is already well underway collecting taxes attributable to the entire 2022 tax year. It is too late to do anything about decisions made in 2022 to realize capital gains. For people who realized large amounts of capital gains in 2022, or who intend on realizing gain in 2023 onward, it is paramount that you seek guidance from your CPA about your newfound capital gains “excise” tax requirements in Washington.

Conclusion

     There are many other tricky elements to this new capital gains tax which are important to get right. We fully expect more evolution in Washington law over the coming years related to this new tax, which will likely increase both the complexity of the tax as well as our own understanding of how this tax impacts our state’s citizens.  For now, we strongly advise clients who have realized substantial gains in 2022, and those who intend on realizing substantial capital gains in 2023 onward, to speak with their CPA and their attorneys about how this tax might impact them.

Washingtons New Capital Gains Tax, What You Should Know

STATE EXCISE TAX

Washington State imposes an excise tax on real estate transactions. The tax rate is currently a sliding scale percentage of the selling price of the property. This tax is paid by the seller at the time of closing, and is based on the total sales price of the property.

There are some exemptions to the excise tax. For example, sales of property between spouses, transfers of property to a trust, and transfers between certain family members may be exempt from the tax.

If you are planning to buy or sell real estate in Washington State, it is important to be aware of the excise tax and how it might impact your transaction. If you need assistance calculating this in conjunction with an accurate estimate of your net proceeds upon sale, contact me for assistance.

PROPERTY TAXES

Washington State Property Taxes are based on the assessed value of real property, which includes land and any improvements on it. The property tax rate is determined by the local government and may vary depending on the location and type of property. The funds collected from property taxes are used to fund local government services such as schools, roads, and public safety.

In Washington State, property taxes are assessed annually, and property owners receive a statement of values and taxes due each year. Property owners have the right to appeal the assessed value of their property if they believe it to be inaccurate.

Washington State also offers various property tax exemptions and deferrals to eligible property owners. These include exemptions for senior citizens, disabled persons, veterans, and low-income households.

It is important for property owners in Washington State to understand their property tax obligations and to stay up to date with any changes in tax rates or exemptions. The Washington State Department of Revenue provides helpful resources and information for property owners on their website.

FIRPTA

FIRPTA, or the Foreign Investment in Real Property Tax Act, is a law that imposes taxes on foreign individuals or entities that sell US real estate. The law requires the escrow company to withhold 15% of the sale price from the proceeds and send it to the IRS to cover any potential taxes owed by the seller. FIRPTA was enacted in 1980 to prevent foreign investors from avoiding US taxes by purchasing and selling real estate without paying taxes on the gains. While FIRPTA can complicate real estate transactions involving foreign parties, it is an important tool for ensuring that foreign investors pay their fair share of taxes on US real estate investments.

Do you have more questions about how all of these taxes will affect your real estate investments? Reach out to me and I will be happy to work through any scenarios regarding your property. I also advise seeking out a qualified tax professional or CPA to figure out the best solution for you.

-John Barker 425.830.0241 john@johnbarker.net