Capital gains tax scenario

[Colton Joseph]

Lets see if anyone can help me with this scenario as I may face it in the near future...

For scenario reasoning lets say I am typically in the 10% tax bracket.

I purchase a lot on January 1, 2016 for $18,000 and start to build a home in June 2016 as a primary residence which costs $160,000 to build. If I were to sell said home on January 2, 2017 for $275,000 what would be the tax implications? Say it is my first home if relevant. Would the capital gains timeline start at the purchase of the lot rather than build of the house? Anyone familiar with the capital gains tax code would be a great help!

[Dave Toelkes]

@Colton Joseph

For capital gains tax rates the holding period must be MORE than one year (one year and a day will do).  If the holding period is one year or less, then the the sale profit is taxed at your ordinary income tax rate.  There is a special 2-year rule for the sale of a primary residence that could exclude up to $250K in profit per taxpayer from capital gains taxes.

Just because you are in the 10% marginal tax bracket does not mean that all of your income is taxed at 10%.  Just means that the next dollar of ordinary income you receive in the 10% bracket will be taxed at 10%.   If the next dollar of income puts you in the 15% bracket, then that dollar will be taxed at 15%.  For each of the tax brackets, income earned in that bracket is taxed at the bracket's rate.

The same holds for capital gains.  The capital gains rates are tiered according to the tax bracket in which the next dollar of capital gains is earned.  Here is how I interpret the tiered structure: 

• If you're in the 10% or 15% tax bracket for ordinary income, then the amount of long-term capital gains that keeps your total taxable income at or below the 15% bracket is taxed at 0%.
• If you're in the 25%, 28%, 33%, or 35% tax bracket, then the amount of capital gains that keeps your total taxable income at or below the 35% bracket is taxed at 15%.
• If you're in the 39.6% tax bracket, then your long-term capital gains rate is 20%.

At some point, if the capital gains is large enough, AMT rules come into play.

The problem with your scenario is how the IRS will perceive your intent.  To avoid having the deal deemed to be a developer transaction, you need to be able to prove that your intent was to build for your own personal use.  Consult your own CPA or tax adviser for specific details regarding your unique circumstances.