In 2020, homeowners in the United States sold 5.64 million homes. If you want to join these millions of people and sell your home, you might be wondering how to avoid paying selling investment property tax. Thankfully, we have the perfect guide to help you out, so keep reading to figure out how to save money!
What is Capital Gains Tax?
Capital gains tax is a tax you pay on any financial (or capital) gain that you made once you sell an asset. The difference is calculated by the amount you paid for the asset and then what you sold it for. You shouldn’t factor in any fees incurred during the purchase.
If you sell a property for more than what you paid for, you’ll have to pay a capital gains tax. If you sell it for less than that, it will be classified as a capital loss. You should always make sure that you hire a lawyer or have a tax advisor to consult to minimize the amount of taxes you’ll have to pay.
Taxes That You’ll Incur When You Sell
In addition to capital gains taxes, you’ll also have to pay a few other taxes. You will have to pay for document stamps on the deed, a 25% depreciation tax, prorations for annual property taxes you owe, and a Medicare surtax.
In addition to the federal taxes, you’ll also have to pay local and state taxes. Some states don’t have them, like New Hampshire, Florida, Alaska, Texas, South Dakota, Nevada, Washington, and Wyoming. Depending on your income, you may also be subject to more taxes or a higher bracket of taxing.
Take Advantage of Section 1031
One thing you can try is using Section 1031. This is a like-kind exchange, and it’s for anyone who reinvests the proceeds of your real estate investment into some new real estate. This way, you’ll be able to defer any of the capital gains tax, you’ll pay taxes only when the exchange is made. However, a “like-kind” trade can be broadly defined in legal terms. You don’t have to buy one condo and then get another condo. You could buy another property that will generate income with rental units, and that could count.
However, you’ll need to time this perfectly. You’ll need forty-five days from the date of the sale to make your identifying replacement property. Then you’ll have to formally close in the next 180 days. If a tax return is due before that period, you’ll have to close it even sooner. If you miss the deadline, you’ll have to pay capital gains taxes on the sale and the original rental property.
Claim Temporary Absence
You may also be able to claim a temporary absence on your residence. This rule applies if you’re going to move out of your main residence. You can treat the property as your main residence. You can do this for up to six years until you buy another property and then rent out the other property.
Use the Main Residence Exemption
The main residence exemption is when you turn your rental property into your own primary residence. Any investor can use this, and it gives you the ability to write off $50,000 in capital gains taxes.
Selling a home you live in will give you fewer taxes than if you are selling a rental property. You can use Section 121 to exclude $250,000 worth of profits from the sale if you’re single. If you’re married, that number doubles. However, to qualify, you’ll need to live in that home for at least two years and own it for at least five. Those years don’t have to be consecutive either.
The amount of tax that is deducted will depend on how long you rented it versus how long you lived in it. However, keep in mind that you can’t exclude a portion of the capital gain that was for the depreciation deduction. This is specific to rental properties, and this tax rate is around 25%.
Time it Right
Before you sell your home, make sure you time it correctly. Is your income going to be lower or higher the next year? If you delay it until then, then you can lower the marginal tax rate and pay a little bit less in capital gains. Or, if you wait until the market is hot, you could have some buy your home.
Do Home Improvements
One way to reduce the capital gains tax when selling property is to start doing home improvement projects. You can keep the receipts for everything that you bought to do those projects. This will include your cost basis, which is normally the cost of your home plus what you paid, plus what improvements you made. If you have a higher cost basis, you may not have to pay as many capital gains taxes. You can do home improvement projects like installing new windows, remodeling, expanding, putting in a driveway, installing an air conditioner, installing a fence, or fixing up your landscaping.
Learn More About Selling Investment Property Tax
These are only a few things to know about avoid selling investment property tax, but there are many more things to keep in mind. We know that buying and selling a house can be stressful, but we’re here to help you out. If you enjoyed this article, make sure that you explore our website to find more articles just like this one.