Last week I published an article about How to Calculate Property Taxes on Residential Real Estate in Panama. This article is also about real estate property taxes, but this time I will tell you about the taxes on a real estate sale based on the current tax laws.
What Kind of Taxes Are Triggered by a Real Estate Transaction?
First the basics. A real estate sale typically triggers 2 types of taxes: a transfer tax and a capital gains tax.
For practical purposes, most people think about these as the 2% transfer tax and the 3% capital gains tax. But, actually, we could more accurately describe the 3% capital gains tax as an “advancement toward the capital gains tax”. I’ll come back to this a little later.
So, when doing a quick “back-of-the-envelope” analysis of a real estate deal, most people will just assume 5% in taxes calculated against the gross sale value of the transaction. That means that if an apartment sells for $100,000, it will usually trigger $5,000 in taxes. And a $200,000 transaction will usually trigger $10,000 in taxes.
If you really just came here for the very basics, then you can stop reading now. But you may have noticed that I underlined the word “usually” (as I often do). That’s because the back-of-the-envelope method doesn’t always tell you the full story.
First, you should know there are multiple exceptions. For example, there are some general tax provisions that allow real estate developers to avoid paying the 2% transfer tax on the first sale. There are more specific tax incentives such as the Casco Viejo law that make exceptions to both the 2% and the 3% taxes.
Second, applying the 2% transfer tax and the 3% capital gains tax to the gross sale price is not always the right way or the best way to calculate the taxes on a real estate transaction. This article is going to explain the correct way to approach this to be sure you don’t over-pay.
Who Pays the Taxes on a Real Estate Transaction?
Generally, the seller pays. What I mean is that if a property sells for $100,000, and the standard 2% transfer tax and 3% capital gains tax calculations apply, then the seller is going to receive just $95,000 from the deal. Sometimes, the seller may negotiate some type of a gross-up of the sales price with the buyer to account for the taxes. Otherwise, by default they will be paid from the seller’s proceeds.
Not only that – the seller is usually the one who actually makes the payment to the tax authority on the DGI’s eTax online platform. And the seller will usually have to present proof of payment of the taxes before the parties will sign the public deed of transfer.
Technically, the seller pays this out of pocket. But in most transactions the buyer will make a down payment at the beginning of the transaction. Once that money goes hard (meaning becomes non-refundable), the seller has some cash on his side of the table.
Understanding the 2% Transfer Tax on a Real Estate Sale
As I said, most people think of this as 2% of the sales price. But the way you should actually calculate it is 2% on the higher of either:
a.) the gross sale value; or
b.) the registered value of the property applying an increase of 5% per year.
So, for example, if you bought the property 3 full years ago for $100,000, then the “registered value” is $100,000. But let’s say that now you are selling it for $200,000. We would calculate the transfer tax as 2% of the $200,000 gross sale price (=$4,000).
But let’s say that instead you decided to sell it for the same price you bought it for 3 ago: $100,000. In that case, we would apply the 2% transfer tax to the price you bought it (the “registered value”), but adjusted with increase of 5% per year (simple, non-compounded).
$100,000 + (100,000 x 5% x 3 years)= $115,000
So the basis for the 2% transfer tax will be $115,000 (=$2,300).
Understanding the Capital Gains Tax on a Real Estate Sale
I mentioned above that we could more appropriately refer to the “3% capital gains tax” as an “advancement toward the capital gains tax on a real estate sale”.
That is because the capital gains on the sale of a real estate property is calculated as the lesser of either:
a.) 3% of the gross sale value (or the registered value if selling at a loss); or
b.) 10% on the profit (sale value minus purchase value).
There are a couple things to note here:
First, the calculation of 5% per year increases to the registered value doesn’t apply here.
Second, if the 10% of the profit results in a lower tax, then you can go with that calculation.
Third, this probably sounds more complicated that it is. Take a look at the examples below.
Examples:
- You bought for $100,000, and you are selling for $200,000.
So we apply the 3% against the $200,000 (=$6,000).
The calculation of 10% on the profit would result in a higher tax ($100,000 profit x 10% =$10,000). So you would pay $6,000.
- You bought for $100,000, and you are selling for $100,000.
So we apply the 3% against $100,000, which represents the gross sale price and the registered value (=3,000).
But there are no profits here, so the 10% of the profits calculation means that there were no capital gains.
- You bought for $100,000, and you are selling for $50,000.
So we apply the 3% against the $100,000 registered value (=$3,000).
But there are no profits here. To the contrary, you sold at a loss. So no capital gains tax is owed.
The way this has worked over the last several years is that you paid the advancement toward the capital gains tax (3% of gross sale value or registered value). And if that turned out to be higher than the actual capital gains tax (10% of profit), then the seller could claim a tax credit or rebate.
However, now the law has changed so that the seller can choose to whether pay either the 3% of sale value or the 10% of profit at the outset.
Bottom Line?
There are 2 types of taxes that the seller usually has to pay on a real estate sale.
The transfer tax is always 2%, but it is applied against either a.) the gross sale value; or b.) the registered value (whichever is higher). And for the purposes of the 2% transfer tax, the registered value is deemed to automatically increase by 5% per year.
The capital gains tax is either a.) 3% of the gross sale value (or the registered value if selling at a loss); or b.) 10% on the profit (whichever is lower).
The best way is to understand this is through examples, and I have included a few in this article. But if you have questions about the taxes that apply to your own real estate transaction, you can write to me at info@theindependentlawyer.com.
