Sell Smart in Michigan: Crack the Capital Gains Tax Code

In real estate, one of the considerations for homeowners contemplating selling their property is the capital gains tax. The capital gains tax is on the profit made from selling a property for more than its purchase price. While the capital gains tax may or may not impact your decision to downsize your home, you will want a general understanding of the capital gains tax prior to selling your home. In this blog, we will demystify capital gains tax in Michigan, using a real-world example to illustrate its application.

What is Capital Gains Tax?

Capital gains tax is a tax on the profit (capital gain) made from selling a capital asset, such as real estate, stocks, or bonds. The tax rate can vary based on several factors, including the length of time the asset was held before sale, the owner's income level, and state laws. For real estate, the primary focus is on the difference between the selling price and the original purchase price, considering improvements and deductibles.

Federal Capital Gains Tax

At the federal level, capital gains tax rates are primarily determined by how long the property was held. Short-term capital gains (on properties held for less than a year) are taxed at ordinary income tax rates. In contrast, long-term capital gains (on properties held for more than a year) benefit from reduced tax rates, ranging from 0% to 20%, depending on the seller's income bracket.

Michigan State Capital Gains Tax

Michigan, like many states, does not impose a separate state capital gains tax. Instead, capital gains are treated as regular income and subject to the state's income tax rate, which is currently a flat rate of 4.25% as of this writing. This simplifies the tax calculation process for homeowners in Michigan, as they only need to consider the federal capital gains tax rates and the state income tax.

A Metro Detroit Example

Let's consider the case of a homeowner in Metro Detroit who bought their home in 1988 for $210,000 and plans to sell their home this year. We have completed an Equity Review Report for this homeowner and we think it will sell for $765,000. Here's how to calculate the potential capital gains tax:

1. Purchase Price: $210,000
2. Selling Price: $765,000
3. Capital Gain: $765,000 - $210,000 = $555,000

This is a rough estimate and approximation. Each homeowner's tax situation is different and we encourage you to to consult a tax professional. 

In the above example, the capital gain is approximately $555,000 but before the tax is figured, you need to consider the following:

Exclusion for Primary Residence: Homeowners can exclude up to $250,000 of the capital gain from their income if single or $500,000 if married filing jointly, provided they have lived in the house for at least two of the five years preceding the sale.

Improvements and Expenses: The cost of any improvements made to the property can also be added to the original purchase price, thereby reducing the capital gain. Selling expenses can be deducted as well.

Assuming this was their primary residence and they meet the eligibility criteria for the exclusion, our homeowner could exclude $500,000 (if married filing jointly) from the capital gain, reducing the taxable amount significantly:

Reduced Capital Gain: $555,000 - $500,000 = $55,000

Keep in mind that we have not included any improvements or selling costs which would further reduce the capital gain. In this example, the $55,000 would be subject to federal long-term capital gains tax rates, which vary based on income, and the Michigan state income tax.

Conclusion

The example above illustrates the importance of understanding capital gains tax when selling property in Michigan. By factoring in federal exclusions and deductions, homeowners can significantly reduce their tax liability, maximizing their profit from the sale. It's always recommended to consult with a tax professional or real estate expert to navigate these considerations effectively.

In summary, while capital gains tax might seem daunting at first, a well-informed approach can help mitigate its impact, enabling homeowners to make more informed decisions about selling their property in Michigan.

If you have any questions regarding the sale of your home or property, reach out to Jeff Higgins at (248) 233-6165 call/text or jeff@higginspartners.com.