Filed under: Capital Gains Tax, State Local & Multistate Tax
Updated on September 26, 2023, to include additional information relating to real estate and terms on capital gains recognized.
Update: On March 24, 2023, the Washington State Supreme Court determined that the Washington capital gains tax is a constitutional excise tax on the sale or exchange of capital assets and not an income tax prohibited under the Washington constitution. Read more here.
In 2021, the State of Washington enacted a new 7% tax on long term capital gains realized by Washington residents and by nonresidents with respect to certain transactions occurring within the state. The tax is effective for transactions occurring on or after January 1, 2022, though it has been challenged on constitutional grounds; a decision from the Washington Supreme Court is expected in the coming months. Because the tax on 2022 transactions is due April 18, 2023, taxpayers must understand the scope and mechanics of the tax in the event the tax is upheld by the court or in the case it has not been decided by the due date. The following Q&A addresses some of the more pressing and interesting questions we’ve encountered regarding this tax.
Q: Who is the tax imposed on?
A: The capital gains tax is imposed on individuals only, and not on business entities. However, the tax does apply to gains passed through from entities such as S-Corporations, partnerships, and trusts. Gains from sales of tangible assets are taxed if the asset is located in Washington at the time of sale or was held in Washington by a Washington resident within the year of sale or the prior year. For example, gain from the sale of a yacht owned by a non-resident would be subject to tax if moored in Washington at the time of sale. A Washington resident yacht owner can potentially avoid the tax by selling their yacht outside of the state, but only if it had not been in Washington since before the start of the previous year.
Gains from intangibles (including stocks, bonds, and ownership interests in privately held businesses) are taxed if the seller is domiciled (i.e., permanently resides) in Washington. Individuals domiciled outside of the state are not subject to the tax on their gain from intangibles. There is a standard deduction of $250,000 per year, so only gains in excess of that amount are subject to tax.
Q: Does the tax apply to sales of real estate?
A: The capital gains tax does not apply to sales of real estate. This exemption applies whether a) a Washington individual taxpayer recognizes a gain on real estate held as an individual, or b) if the real estate gain was passed through from an entity. Capital gains from the sale of an entity holding Washington real estate are also exempt, to the extent that the gain is “directly attributable to the real estate owned directly by such entity.” The Department of Revenue has indicated that depending on the circumstances, gain may be bifurcated on the sale of an entity that owns both real estate and other assets based on a) an appraisal of the property held by the entity, b) a purchase price allocation agreed to by the buyer and seller, or c) the current property tax value of the property at the time of the sale.
Q: Does Washington tax gains from Qualified Small Business Stock?
A: Federal income tax law provides up to a $10 million gain exclusion for sales of “Qualified Small Business Stock” (QSBS), provided certain holding period and other requirements are met. Since federal long term capital gains are the starting point for calculating the Washington tax, Washington will implicitly allow this exclusion in the year it is recognized for federal tax purposes. This becomes more complex if the taxpayer cannot utilize the federal exclusion in full the year the stock is sold and generates a federal carryover. Washington law is silent as it pertains to any prior unutilized or carryover QSBS exclusion amounts.
Q: Are there any other ways to exclude gain from sale of a family business from the Washington tax?
A: A separate deduction from the Washington capital gains tax is available for gains from the sale of a “qualified family-owned small business (QFOSB).” The definition of a QFOSB is quite different than the federal QSBS requirements. Generally, a QFOSB must have annual worldwide gross revenue of less than $10 million and the business must either be majority owned by members of the taxpayer’s family, 70% owned by members of two families, or 90% owned by members of three families.
Q: Is tax imposed on capital gains recognized without a sale or exchange occurring?
A: No, gain must result from a sale or exchange of capital assets for the tax to be imposed. Under certain circumstances (e.g., a partnership distribution in excess of the partner’s basis, or an individual permanently expatriating from the United States), federal long term capital gain is recognized without the occurrence of a sale or exchange. In these situations, the resulting gain is not subject to the Washington tax.
Q: Can I net short term capital losses against long term capital gains?
A: No! For federal tax purposes, taxpayers can generally reduce their total long term capital gain for a given year by their total short term capital loss for the same year, and are only taxed on the net gain remaining, if any. However, since Washington only taxes long term capital gains, short term gains or losses are simply ignored in calculating the tax.
Q: How are installment sales taxed?
A: Generally speaking, taxpayers who report a sale on the installment method for federal tax purposes will report the long term gain to Washington as the installment payments are received. However, if the original sale took place prior to 2022, the Washington Department of Revenue has issued guidance that none of the installment payments are subject to the Washington tax.
Q: Can I apply capital loss carryovers?
A: Yes, but the carryover is limited to the amount of capital loss carryover utilized in calculating federal net long term capital gain and is further reduced if any of the carryover was generated from transactions sourced outside of Washington under the imposition rules discussed above. Also, loss carryovers generated prior to the January 1, 2022, effective date of the Washington tax cannot be used to offset or reduce the tax due.
Q: Does the tax apply to sales of cryptocurrency?
A: Since cryptocurrency is an intangible asset, the Washington tax will apply to such sales by individuals domiciled in Washington, provided it is held for at least one year prior to the sale. Nonresidents of Washington are not subject to Washington capital gains tax on their cryptocurrency sales.
Q: Is the Washington tax imposed on gains from the sale of art and collectibles?
A: Yes, if the item is located in Washington at the time of sale, or if the seller is a Washington resident and the item was located in Washington at any time during the year of sale or the prior year.
Q: How do I file a return and pay the tax?
A: Returns are required to be filed electronically through the state’s MyDOR portal, and any tax due must be paid by EFT or with credit card. The Department of Revenue can waive the electronic filing and payment requirements for good cause. A filing extension will be granted if the taxpayer files a federal extension and requests a Washington extension prior to the original due date, but the tax must still be paid in full by April 18th (April 15th in future years). Any tax paid after that date is subject to a late payment penalty of up to 29% of the tax due.
Conclusion
It is important for taxpayers to understand the pending applications of Washington state capital gains tax for their transactions. Tax considerations may differ depending on the product assessed, the entities or individuals involved, and the location of the transaction. If you have questions on determining your Washington state tax responsibility, please email us and we’ll be happy to help.
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