The earnings you can gain from trading a real estate investment may look enticing. But if you examine the Federal Capital Gains Tax you’ll need to meet — which can be as steep as 37% — there may not be a lot of profit accounted in your possession after you settle that tax bill.
Here’s the upside: There are several ways to lessen and/or defer your Capital Gains Tax exposure so you can keep a more significant share of your profits.
- Wait at least one year before trading a property
When you trade an asset, you’ve possessed for less than a year, the profit is deemed to be short-term capital gains, which will be eligible to be taxed at a federal rate of up to 37%.If you sell the same property after retaining it for over one year, the profit is listed as long-term capital gains, which has a reduced tax rate of 0% to 20%.Holding onto the property until it passes as a long-term investment could decrease your federal tax burden significantly.
- Take advantage of the IRS’ Primary Residence Exclusion
You can be spared from paying Capital Gains Tax when you sell a primary residence that satisfies specific criteria. Individuals can be excluded for up to $250,000 of capital gains while a married couple can be given a free pass for up to $500,000.
Under the Section 121 exclusion, you’ll have to possess and maintain the property as your primary residence for two out of the five years immediately heralding the date of the sale. Also, to be eligible, you should not have taken a capital gains exclusion for a different property sold at least two years prior to this current sale.
This strategy only applies to a single property utilized as a primary residence; hence, it won’t profit investors dealing with multiple investment properties.
- Sell your property when your overall income is low
Capital Gains Tax rate is defined by your tax bracket, which is estimated based on your earnings. Planning the time of sale could have a definite bearing on your tax load.For example, if you or your spouse lose or quit a job, or if you decide to retire – it will be a better option to sell your property.This is obviously not a very convenient option for many investors.
- Maintain documents of home improvement and selling expenses
In case you’re selling your primary residence, always keep track of the costs linked with renovating and selling the home.Home improvements or additions delivered to the property over the years can add to your basis in the property, lowering the capital gains when sold.Also, the expenses will be deducted further reducing the amount of Capital Gains Tax due.This strategy is suitable for a primary residence. However, real estate investors with multiple properties might not benefit much.
- Invest in Opportunity Zone Funds
Many distressed areas are designated as “Opportunity Zones” to incentivize investments in housing, small businesses, and infrastructure in those regions. This investment can defer all capital gains for 8 years provided the profits are reinvested and kept in an Opportunity Zone.
- Take use of the 1031 Exchange
1031 Exchange was developed to stimulate investment in the real estate market and to urge investors to put their money back in the system. From a personal standpoint, this process will allow you to defer the capital gains tax on the trade of a property if you reinvest it in another like-kind property. However, some qualifications must be met to achieve a successful exchange.
The asset needs to be held for a year or longer to be eligible for the long-term capital gains tax rate as it is significantly lower than the short-term capital gains rate for most assets. The gains from the initial sale are usually handled by a qualified intermediary and securely retained into a trust. The investor gets 45 days to identify suitable like-kind replacement properties and to notify the IRS. The “reinvestment” or acquisition of the chosen properties must take place within 180 days of the sale of the initial property. If any of the guidelines laid by the IRS are not met, the money in the trust will be subject to the appropriate capital gains tax. You have a range of prospects for 1031 exchanges. Properties differing from small retail outlets to huge industrial complexes can pass; even smaller investments in investment grade real estate deeded as “tenants in common” (TICS) can qualify.
Engage our services for a profitable 1031 Exchange
1031 Exchange enables your money to churn the maximum profit for you. However, the exchange process is extremely complex in nature, and it would be wise to seek guidance from expert professionals. We have extensive experience in handling highly profitable exchanges for our varied client base.