Real Estate Capital Gains Tax in South Carolina: What Is It and How to Avoid It
Real estate can sometimes be a complex subject. There are many advantages to buying, holding, renting, and even selling real estate. Unfortunately, the tax laws can sometimes seem opaque and, if you're not careful, you could trigger a massive tax bill without even realizing it. One area where investors and homeowners can sometimes find themselves afoul is the real estate capital gains tax. This tax can sometimes rear its ugly head, especially if you're looking to downsize from a high cost-of-living place to a lower cost-of-living one. Or, if you're looking to sell a rental property, you might wind up triggering a tax debt there, too.
No matter what type of property you're looking at buying or selling in South Carolina, it's usually best to understand your potential capital gains situation first. Not doing so could leave you with a hefty bill to the IRS!
Real Estate Capital Gains Tax: When Does It Apply
Part of the reason why many homeowners are caught off-guard is that the real estate capital gains tax is not entirely straightforward. It will apply to some people and not others.
Federal Capital Gains
Federally, the capital gains tax usually applies when one of the following conditions are true:
- You are selling a second or investment home.
- You sell your primary residence and have a capital gain of more than $250,000 for single filers or $500,000 for joint filers.
If you are selling a second home, not your primary residence, you will owe capital gains on the total increase in the value of your property from the time you bought it to the time you sold it. As a quick example, if you purchased an investment property for $200,000 and sell it for $500,000, you'll owe real estate capital gains tax on that $300,000 increase.
You may also owe capital gains tax on the sale of your primary residence. However, it is not guaranteed. Section 121 provides an exclusion amount of $250,000 for single filers and $500,000 for joint ones for the sale of any home that you have used as your primary residence for at least two of the past five years. If you sell your home for a gain that is more than the exclusion amount, you'll pay capital gains tax on the amount above it.
As a quick example, if you bought a home as a single filer for $200,000, lived in it for five years, and are now selling it for $400,000, the Section 121 exclusion means you won't pay any capital gains taxes. However, if you sold it for $500,000, you would owe the tax on $50,000 ($500,000 selling price - $250,000 exclusion - $200,000 original price = $50,000 taxable).
Lastly, please note that those on extended duty in the military can elect to suspend the five-year test for up to ten years.
South Carolina Capital Gains
If you are selling your home in South Carolina or considering buying an investment property here, you should know that South Carolina does, indeed, have a capital gains tax, too.
South Carolina levies a 7% long-term capital gains tax. There is no exemption for primary residences, so any property you sell will cost you 7% on any difference between the price you paid and your selling price. However, 44% of the capital gain is exempt. So, in reality, the actual rate you're paying is just 56% of 7%, which is 3.92%. So, if you sell a home for a $100,000 profit, you should expect to pay $3,920 to the state in real estate capital gains tax.
Is It Possible to Avoid These Taxes?
The top federal capital gains tax rate is 20%. The effective state rate is 3.92%. Combined, that means it is theoretically possible to lose up to 23.92% of your home's increased value to taxes alone! That means, if you take advantage of appreciation and your home sells for $500,000 above what you paid for it many years ago, you could owe up to $119,600 in taxes, both to South Carolina and the Federal government.
The prospect of such a tax bill leads many to wonder: is there any way to avoid these taxes?
There are two ways to minimize the amount you will pay for federal taxes. The first way, as discussed above, is the Section 121 exclusion which exempts $250k/$500k from this tax. For many primary residences in the Charleston area, this might be enough. Investment properties cannot use Section 121, but they can conduct a 1031 exchange. This provision lets investors swap similar property. So, if you have a $500,000 home, sell that, and use the proceeds to buy an $800,000 multi-family unit, you can use a 1031 exchange to avoid capital gains tax on that $500k sale.
The complete nuances of these rules are beyond the scope here, but a 1031 exchange is arguably the best way to avoid this tax on rental properties.
Unfortunately, there is no provision in South Carolina like Section 121 for primary residences. When you sell a property in South Carolina that you have lived in, you should expect to pay tax based on how much it has increased in value.
However, South Carolina does recognize 1031 exchanges. So, you may be able to avoid paying capital gains tax altogether whenever that situation applies!
Proper Real Estate Capital Gains Tax Planning Is Essential
Before selling your home, whether it's a second home or your primary residence, it may be a good idea to understand your potential tax implications before you put the house on the market. With proper planning, it's sometimes possible to legally minimize or even eliminate the amount you could owe!
Lastly, please remember that the advice given above is, of course, general guidance. Please make sure you speak with a tax accountant or attorney to get more specifics for your particular situation!
When you are ready to sell or buy a home in Charleston, we would love to hear from you! Please get in touch with us, and we will be happy to guide you through the process!