Avoid or Minimize Capital Gains Taxes
Today, we’re talking about how we can pay little to no capital gains taxes using real estate. It’s no longer a secret that real estate is an amazing investment but investors are still not using it to its full potential.
What Are Capital Gains?
So what are capital gains? Basically if you bought an asset for one price and sold it for a higher price, your “capital” has gained value and therefore you will owe taxes on that gain.
There are two different forms of capital gains: short-term and long-term. If you own the asset for less than a year and then sell, that profit is taxed as ordinary income just like your income from your job would be. However, if you hold an asset for more than 1 year and then sell, you’ll now have a lower tax rate called long-term capital gains tax. It’s a no-brainer to try to end up in the long-term category; however as real estate investors, we can make the long-term capital gains tax even lower or non-existent with a few creative strategies…
7 Strategies to Avoid or Minimize Your Capital Gains Taxes
Hold Onto Your Property for at Least a Year
As we spoke about, buying and then selling a property in less than a year is detrimental to your tax bill. The profit you made in the sale is going to be subject to short term capital gains (think: house flippers). You could avoid the short term capital gains rate by stabilizing the property with a tenant and then renting it for one year. Then, sell the property after the tenant’s lease ends. You would now be paying a lot less in taxes by being in the long-term capital gains bucket!
Live in Your Property for at Least Two Years
When I learned about this tax strategy it blew my mind. There is something called the home sale gain exclusion which says that when a primary residence is sold, up to $250,000 in capital gains can be excluded from taxation as long as you’ve lived in the property for 2 of the last 5 years. That limit increases to $500,000 for married couples. So you can theoretically buy a new primary residence every 2 years over the course of your life and roll over the gains to bigger or better homes tax-free or just take the money in cash tax-free. You could also do renovations to the property while living in it to make it appreciate more in value. Savvy investors often call this the “live-in flip” strategy.
The 1031 Exchange
The 1031 exchange strategy is basically exchanging one investment property for another property and defer the capital gains. You can use the 1031 exchange as many times as you want so you could technically defer gains forever. Check out my video about the 1031 exchange for more details on how the 1031 Exchange works.
Buy Real Estate Inside a Self-Directed Roth IRA
This is another tax strategy that absolutely thrilled me when I heard about it. I thought buying stocks inside of a Roth IRA was good due to the tax free growth it provides, but you can do it with real estate too! Make sure you abide by the rules of the self directed Roth IRA but if you do, all your gains on appreciation and income will be tax-free when you retire when using this strategy. No capital gains taxes for you!
Record All Costs of Capital Improvements on the Property
This strategy is a bit nuanced when trying to minimize capital gains. You’ll want to keep good records of all capital improvement projects you do while owning the property because those costs can be added onto the cost-basis of the property and narrow the gap that you would pay gains on. The nuance to this is that you don’t want to go out and make improvements that increase the property value just for fun, because then you’ll command a higher price for the property and end up with the same spread of capital gains. Just keep good records of costs when a new roof or hot water heater goes in and it will help you out when it comes time to sell!
Sell Your Property When Your Income is Low
I don’t know about you guys, but I plan on retiring with more income than what I’m making now, but that doesn’t mean there aren’t dips in net worth and earnings throughout one’s career. If you find yourself in a situation where you’re making less than $39,375 in adjusted gross income and have a property to sell, go ahead and sell it and by being under that income threshold, you won’t owe any capital gains taxes on your profits.
Gifting Properties to Your Family Posthumously
If your estate plan is to transfer wealth to your children, you’ve come to the right place! If you give your children your real estate after you die, the tax-basis gets stepped up to the fair market value of the property and capital gains taxes become no longer applicable if your child sells the home for the same amount as the stepped-up tax basis. You could also give your child your real estate while you’re living and then have them live in it for 2 of the previous 5 years before the sale, then when they sell the property they will realize those gains tax-free!
Remember, get creative and educate yourself in real estate to make sure you’re using the asset class to its fullest potential. Myself and the Rent to Retirement team look forward to working with you!
Howdy! Do you use Twitter? I’d ⅼike to follow yоu if
that woᥙld bе okay. I’m ⅾеfinitеly enjoying your blog and
look forward t᧐ new posts.