Insights: Understanding Tax Laws for Buyers and Sellers of San Francisco Real Estate

Do you plan to invest in or sell Pacific Heights real estate in 2021? The taxes involved in both buying and selling property are more complex than ever before. And though it’s always a good idea to work with a professional accountant who has experience with the real estate industry when purchasing or selling property, it also helps to know a bit about the tax laws yourself. Here are the basics of what you should know about taxes and how they affect your real estate transactions.

Tax Implications for Buyers

When you buy a San Francisco condo or single-family home for sale in Pacific Heights, Presidio Heights, Russian Hill, or the surrounding neighborhoods, you will receive a number of tax benefits. These include:

◾ The ability to deduct certain amounts of mortgage interest paid on your taxes.
◾ The ability to deduct certain amounts of real estate taxes you pay on the home.
◾ Interest that you pay on private mortgage insurance.
◾ Withdrawals from your IRA that are penalty-free if you are a first-time homebuyer and under the age of 59 ½.
◾ Residential energy credits.

If you are buying Pacific Heights, Presidio Heights, Russian Hill, or surrounding neighborhood real estate as an investment property that you will rent out for extra income, you receive these benefits:

◾ The ability to deduct certain amounts of mortgage interest paid on your taxes, even if you’ve taken out a second mortgage to buy property.
◾ Any insurance premiums you pay on the home, including health insurance and workers’ compensation, if you have employees to help you maintain or manage the property.
◾ Depreciation of the value of the rental property and its contents.
◾ Any maintenance and repairs necessary to keep the property in rental condition but that do not add significant value to the home.
◾ The utilities, such as gas, electricity, or water that you choose to cover for your tenants.
◾ Any fees for professionals you use to help you manage your properties.
◾ Fees involved in traveling to your rental property to collect rent, show your property, or perform maintenance duties.

Keep in mind that if you are buying condos for sale in Pacific Heights to use as income sources by renting them, you will have to pay taxes on your rental income. Both U.S.-based investors and foreign investors must pay these taxes. Foreign investors can pay taxes in two ways:

◾ By electing to have 30% taken from each of their gross rental payments by a withholding agent who then forwards it directly to the IRS.
◾ By agreeing to prepare a U.S. tax return to report the amount of rental income they receive each year. To do this, the investor needs to apply for an Individual Taxpayer Identification Number and fill out a Form W-8ECI.

Tax Implication for Sellers

Ready to sell your personal home or investment pieces of Pacific Heights real estate? You will need to pay taxes on the profit over $250,000 you make from the home if you have lived in it for at least two of the five years before the sale. This doubles to $500,000 if you are married and filing jointly.

If you are selling investment property and have made upgrades that increase the value of the property, the cost of the upgrades is tax-deductible.

The biggest issue when it comes to selling investment properties is paying interest on capital gains. Capital gains occur when you sell an investment property for more than you paid for it. There are two types: short-term and long-term capital gains, each of which is treated differently by the IRS. If you sell a property you held for one year or less, it is considered a short-term capital gain and is taxed as ordinary income. If you hold the Pacific Heights real estate for more than one year, it is considered a long-term capital gain and is taxed at a lower rate of 0%, 15%, or 20%, depending on your filing status and income.

To avoid capital gains taxes altogether, many investors in Pacific Heights real estate opt to do a 1031 Exchange. This is when an investor swaps one investment property for another. When the investor sells his property, he puts a portion of the proceeds with an intermediary. The intermediary holds the money until a new property is identified, then uses that money toward the purchase of the new property. 

1031 Exchanges must follow certain rules. They include:

◾ The properties must both be like-kind. For example, an investor can exchange a rental property for a rental property but cannot exchange a rental property for a piece of land they will not make income from.
◾ The investor must buy a property of equal or greater value than the property they are exchanging it for.
◾ The exchange must follow a set timeline. Investors must identify a replacement property within 45 days of selling their initial property (called relinquished property) and close on the replacement property within 180 days of closing on the relinquished property sale.
◾ 1031 exchanges cannot be used on personal property.
◾ The intermediary used in the transaction must be qualified and cannot be related to you or serve you in any professional capacity, such as your banker, accountant, or attorney. The intermediary must know how to perform the exchange property to help you avoid any tax consequences or void the exchange entirely.

If you are planning to buy or sell Pacific Heights condos either for your personal home or for investment purposes, it’s important to know what tax implications you will face. Working with a qualified attorney or accountant who is experienced working with those in the real estate industry is always recommended. You should also choose a Pacific Heights real estate agent who can answer tax questions or direct you to a professional who can answer tax questions for you.

Ready to move forward with your real estate transaction this year? Reach out to experienced local agent Gregg Lynn to schedule a consultation.