There are many expenses involved when selling real estate and taxes is one of the biggest, especially if you have to pay capital gains.
However, if you know the tax rules then the amount of taxes you pay (if any) can be drastically reduced. Let’s cover a few ways to reduce that tax burden.
Reducing Capital Gains Taxes on Real Estate, Legally!
1.) Short-term vs Long-term capital gains
Properties that are held for more than a year are taxed at the long-term capital gains rate. This is noteworthy because that tax rate is 0% up to $39,475 for a single filer. Then it jumps to 15% and holds there all the way up to $434,000.
If you buy and sell a property within one year then it’s taxed as short-term gains and you pay the ordinary income tax rates which start off at 10% up to $9,700 and progresses to 12% up to $39,475 before jumping to 15% and so on and so forth with 37% being the top tax rate.
2.) Increase Your Cost Basis
The price you pay for a property is your cost basis in the eyes of the IRS. Meaning if you spent 150K to acquire a property and sold it for 200K then you have a 50k taxable gain.
If you completed capital improvements on the property those costs can be added to your costs basis though. Be sure to keep those receipts so you can tack on that 8K cost for a new roof and reduce the tax burden.
3.) Do a 1031-Exchange
Many investors have heard of this one and it gives you the ability to not pay capital gains (or technically postpone them) on the sale of a property by rolling the money into another property.
It’s deemed a “like-kind” exchange meaning you sell an investment property to buy another investment property that is used similarly.
There is a 45 day window to identify properties to the IRS that you plan to buy and then you must close on one of them within 180 days to avoid triggering the capital gains tax.
Plenty of other rules and methods…
Those are just three ways to alleviate the tax burden, there are many other options out there such as investing from a self-directed IRA and so on. This is why it’s important to have a solid account knowledgeable in real estate investing.
Be sure to have them work you through the all the options and verify the examples I have given above as I’m an investor, not an accountant.
Having to pay some taxes is a good problem to have. It means you are doing profitable deals and are buying right. Always use the property calculator to ensure you buy right!