What is the Difference between Long-Term and Short-Term Capital Gains?
Are you going to be selling stocks, a business, or possibly real estate in 2024? Before selling, it is critical that you understand the difference between long-term and short-term capital gains.
If the investment is held for more than one year (365 days), the capital gain or loss is long-term.
If the investment is held for one year or less, the capital gain or loss is short-term.
That’s as simple as it gets.
Long-term capital gains (LTCG) are taxed at a VERY reduced rate compared to short-term gains (STCG). The tax rate for LTCGs is taxed between zero and twenty percent. The tax rate for STCGs is at ordinary income, which could be as much as thirty-seven percent.
When property is inherited, the capital gain (or loss) when the property is sold is treated as a long-term capital gain. This treatment is true regardless of how long the taxpayer held the inherited property. (IRS Publication 551). Should a beneficiary elect to sell an inherited building or property, this could be a huge benefit.
Even better, the basis is stepped up upon the death of the original owner. Therefore, the basis (cost) for determining the capital gains tax is generally higher than what the original owner paid because the basis is at fair market value, not the price paid by the original owner. Buildings are especially likely to receive a step-up in basis.
The delta between the basis (cost) and sale price determines the tax liability owed to the IRS upon the sale. A step up in basis means the cost is not what the original owner paid but the fair market value at the time the original owner passed away.
There is an alternate valuation method, which is the fair market value six months after the original owner passes. In a very hot real estate market like we saw in 2021, this can be very advantageous. This alternative valuation date is only valid if the property is not sold or distributed within six months after the decedent’s death. If the property is sold, the value that is used to determine the basis is the value of the property at the date of sale.
If you own a building, a cost segregation study combined with the step-up in basis is almost too good to be true. A study done during the original owner’s life will create a very nice tax deferral by accelerating a portion of the depreciation. Generally, this accelerated depreciation will reduce the basis and increase the taxes owed upon the sale of the property. So, in theory, the accelerated depreciation is “paid back” at the ordinary income (as high as thirty-seven percent) bracket at the time of sale. Non-accelerated depreciation is paid back at twenty-five percent. This is referred to as depreciation recapture.
There is no recapture from a cost study done by the original owner when they passed away. The deferral becomes a permanent deduction. Even better, the depreciation clock starts all over again, which means another cost segregation study can be done on a new, higher basis for the property.
If you have parents or grandparents who own buildings or rental properties, suggest having them do a cost segregation study, especially if you or someone close to you will inherit the property.