Property investment can be very profitable and lucrative, but there are several stumbling blocks to overcome, including figuring out how to sell the investment property without paying taxes.
Whether you’re thinking about buying a rental home or selling a house or condo you currently rent out, it’s a good idea to learn everything about rental real estate taxes and how it works.
The ultimate goal of any real estate owner is to make as much profit as possible from the purchases, sales, and rentals of their property. There’s a high chance of losing a lot of money if you pay capital gains tax on an investment property sale, particularly for those within the high earner tax bracket.
What is capital gain?
A capital gain is an increase in the net value an investor earns after selling a capital asset. Capital assets refer to everything an investor owns and uses for investment.
After selling an asset, you can calculate the capital gain or loss by subtracting the amount realized from the property’s sale from the adjusted basis.
There are four essential terms every investor should understand to determine the capital gain.
The capital assets are significant properties, including equipment, tools, stocks, bonds, furniture, and buildings.
The adjusted basis refers to the initial purchase price of the capital asset, comprising the legal and recording costs, surveys and conversion charges, title insurance, and sales commissions.
Short-term Capital Gain
They are investment properties an owner holds for one year or less before selling them.
Long-term capital gain
They are investment properties an owner holds for over one year before selling them.
For investors looking to minimize their tax burdens and sell their investment properties without taxes, there are several ways you can follow to avoid paying capital gains tax on rental property.
There are three main strategies:
1031 Real Estate Exchange
One option real estate investors can use to avoid tax on investment property sale is to reinvest the revenue from selling one property in another similar acquisition.
With a 1031 real estate exchange, investors can toss the profits of one deal into another similar investment property available.
If you want to go this route, you’ll agree on the terms of your rental property’s sale, and ownership will be passed to a chosen intermediary.
The intermediary is responsible for selling the property, and they’ll collect the payment and keep it for you until you discover a desirable property to secure.
Once you’re ready to buy the property, the intermediary then releases the cash and oversees the property’s acquisition. The 1031 exchange offers investors opportunities to avoid paying capital gains tax or depreciation recapture taxes when purchasing new rental assets.
This process helps defer the fees and taxes until you sell investment property without acquiring another. Investors can use a 1031 exchange on any number of assets, and it’s an ideal choice for investors looking to grow their real estate portfolio.
Offsetting Property Gains with Losses
Often referred to as tax-loss harvesting, this technique is primarily useful for investors that encountered capital losses in a tax year. It entails minimizing tax liability by combining the profits from the sale of a property with the loss incurred from another investment.
This strategy can be used as a tax minimizing tactic if an investor owns a depreciating asset and decides to sell it at a loss in the same year they profit from an alternative investment property sale.
Although stocks and shares investors mainly use this strategy to offset profits from stock investments, it is beneficial for real estate investors. Since the IRS allows pairing profits and losses when calculating the total amount of taxes, this approach works well.
Using Your Rental Property as a Primary Residence
Another method investors can use to minimize tax on investment property sales is and using the rental home for a primary residence. Taxes are more significant when selling a property for profit than selling the property as a homeowner.
According to IRS Section 121, if you are unmarried, you can exclude about $250,000 from the profit made from selling your primary home. If you are married and have owned the property for at least five years, you can deduct up to $500,000 from the profit.
Only those who have lived in the house for at least two years are eligible. The sum you can subtract is determined by the length of time you’ve owned the home and how long you’ve lived there as your primary residence.
For example, if you purchased a house and leased it out for three years before staying in it for two years, you could subtract up to 40% of the capital gains tax.
Tax on Sale of a Rental Property Calculator
There are now different calculators available to help investors find out how much rental property taxes they have to pay, as well as where they can make savings.
Using these calculators will save you a significant amount of money on your rental property tax bill. It can also provide you with a great visual indication of how you can reduce your rental tax bill, including the capital gain tax, even further when you sell an investment property.
You can find more information from this article that explained, “how much tax do you pay when you sell a rental property?”
Investing in real estate properties can guarantee a steady income for investors. However, without proper planning, real estate investors are liable to lose a large chunk of their profits to capital gain tax when selling an investment property.
The strategies explained above will provide investors with techniques to lessen, defer, or avoid paying capital gains tax on rental property sales.
It’s also a good idea to use tools like the tax on rental property calculator or even employ a professional accountant to help you work out these calculations to make sure you have the best possible rental property sale tax savings.