Income Tax Zeek Zapota owned forty acres along a main road between the downtown
ID: 2593543 • Letter: I
Question
Income Tax
Zeek Zapota owned forty acres along a main road between the downtown area and an affluent suburb of Reno, Nevada. He obtained the property for $500 per acre in 1955. Zeek gifted the property to his daughter, Zella, in 2005. An appraisal estimated that the property value at the time of the gift was $5,000 per acre.
Recently, Zella received an offer of $12,250 per acre.
Explain the income tax implications for Zella of an outright sale of the property.
Is there an alternative to the sale which might allow Zella to escape current income taxes? Explain how that might work.
Explanation / Answer
Since the property was held for more than a year it would be considered under Long term capital gains Tax bracket.
Long-Term Capital Gains Tax Rates
The IRS taxes long-term capital gains at a substantially reduced rate as a means of encouraging individuals and businesses to keep their investments. The difference between the long-term capital gains rate, generally referred to as simply the capital gains rate, and the ordinary income tax rate, which applies to short-term gains, can be as much as 20%.
In 2015, the capital gains rate for those in the 10 and 15% income tax brackets is 0%, meaning those who earn the least are not required to pay any income tax on profits from investments held longer than one year.
For those in the 25 to 35% tax brackets, the capital gains tax is 15%. For the wealthiest citizens who fall into the 39.6% income tax bracket, the capital gains rate is still only 20%.
Assume that, in the example above, suppose your $5,000 in investment income is from long-term investments held longer than a year. In this case, your tax bracket as an individual would still be 25%, but just for the $60,000, on which you would owe $10,793.25. You would only pay 15% on your capital gains, for an additional $750. Instead of a total tax liability of $12,021.25, you would only owe $11,543.25 for the same amount of income. The greater your investment income, the more important this distinction becomes.
The rate varies based on your income tax bracket and the investment type, but for real estate in 2016, capital gains tax tops out at 25% for investment properties.
So apart from the data given above we must also know the income bracket of Zella.
Now that you know the tax bracket for calculating capital gains then you must apply the same along with income of Zella. Hope this answer gives you clarity while approaching any situation related to capital gains taxtation.