Is This Taxable To You?

Good Morning Relaxing Retirement Member,

Income taxes…payroll taxes…sales taxes…property taxes…estate taxes… gasoline taxes…excise taxes…capital gains taxes…

There is certainly no shortage of ways that you are taxed.  Your “patriotism” (translation: support of government functions) should never be called into question.

However, the good news is that not all of the money you receive is subject to income taxes.

As I do every year around tax filing time, I’ve recently received a lot of questions in this area from many of you, so I thought I’d outline sources of money that are definitely not subject to income taxes.

There’s a lot of confusion out there about this, so let’s walk through some of them:

  • Gains on the sale of your home: For starters, only the ‘gain’ is potentially taxable, not the entire sales price.  Over and above what you paid (plus capital improvements), $250,000 of gain ($500,000 for couples) on the sale of your primary residence is free from capital gains tax.

    So, for example, let’s say that you bought your home years ago for $300,000 and today it’s worth $1,000,000 if you sell it.

    Assuming for a moment that you’ve made no capital improvements to your home (additions, new rooms, etc.), you would have a $700,000 gain on your hands when you sell your home.  From that, you first subtract any real estate agent commission.  Assuming a 5% rate, that’s $50,000, so now we’re down to a $650,000 gain.

    If you’re married, you may exclude $500,000 of that gain from capital gains taxes, so only $150,000 would be subject to taxes, not $1 million or $700,000.

    To qualify for this exclusion, you must have owned and used your home 2 out of the last 5 years from the date of the sale.

  • Life Insurance Proceeds: Proceeds that you receive as the beneficiary of a life insurance policy are free of income tax to you.  They may be subject to estate taxes, but estate taxes are paid on the estate level before you receive the proceeds.  (I’ll be discussing how to avoid having your life insurance subject to estate taxes in another Strategy in the near future)
  • Gifts and Inheritances:  You do not pay income tax on money or property you receive as a gift or inheritance.  This is a question I receive at least once a week.  The good news is that any gift tax that is owed is the responsibility of the person who gave the gift.  And, in the case of an inheritance, federal estate taxes are paid by the decedent’s estate, not by you (the beneficiary).

    If you inherit property (such as a home) that has increased in value since the decedent purchased it, you do not pay income tax on that gain.  Your cost basis in the property, for the purposes of calculating any potential income taxes due, is the value on the date of death.  This enables you to avoid tax on the gain when you sell it.

    ** Caution: If you hold it for several years and the home (or any other asset) appreciates in value, you will be liable for taxes on the difference in value from the date of the decedent’s death and the date you sell the asset. **

  • Damages: Any damages you receive in a lawsuit due to personal physical injury or sickness are tax free.

    However, be sure to understand the difference between damages and disability policy claims.  If your employer pays for a disability policy in your name, benefits paid to you are taxable as income to you.

  • Life Insurance Policy Dividends: These are generally considered a partial return of the premiums you paid and are not taxable.  You don’t owe tax on these dividends until they exceed the accumulated premiums you’ve paid over the years for the policy.

If you ever have any confusion about calculating a tax that you believe you owe, please don’t hesitate to call our office for clarification.  There’s no sense paying any more tax than you’re legally obligated to pay.

You’ve paid your “fair share” already.

Committed To Your Relaxing Retirement,

Jack Phelps

The Retirement Coach

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