This is my first post and I have been a “lurker” for months and months now. ;D Before I get into real estate I need some help understanding Capital Gains Tax. I know we are taxed at our income tax rate, but what exactly are we taxed on? Here is my hypothetical deal that I have structured my question around. TIA for reading this and helping me out.
If I purchase a home for $100,000 and then sell it for $165,000, but my bills are $31,000 (Gave $7,000 to seller, cost $10,000 to fix, Appraisal Title and such was $3,000, Realtor fee to sell was $11,000) Do I get taxed on the $65,000 or the $34,000.
You all are fountains of information. Thank you so much for your answers!
As a general rule, if you subtract all your expenses from your income on this hypothetical deal, the remainder is your profit. When the dust settles, profit is what you have in your pocket to invest in your next deal
Your profit – $31K in your example – is what is taxed.
OK, a more specific question then is, how does the government know to tax me on the $34K and not the $65K? I’m assuming when I do my taxes at the end of the year there is a form my accountant will submit telling them what my profit was? I find it hard to believe that they’ll just take my word for it.
I’m not doubting your answer. Just trying to understand the process. I don’t want to think I’ve made a bunch of money on a deal only to find out later that I have to give 30 plus % of it to Uncle Sam.
Thanks again! ;D
Yes, the IRS takes your word for it when you file your tax return. If you are audited, you will be asked to prove that your expenses were justified and therefore allowable. You prove your case with your supporting documentation – HUD-1s, receipts and paid invoices.
When you purchase the property, the settlement attorney will give you a HUD-1 (form) that will document all the closing costs and distribution of funds brought to the settlement table. It should even show the amount you returned to the seller.
For your fixup costs, you should have all your receipts and contractor invoices.
When you sell the property, once again your sales commission and the seller’s closing costs will be documented on the HUD-1 you will receive from the settlement attorney.
Remember President Regan’s attitude toward the USSR near the end of the cold war was “trust but verify”. That can also be said of the IRS’s attitude toward taxpayers. The IRS will accept your tax return at your word, but if anything looks odd you may be asked to verify.