Capital gains taxes (CGT) can represent a significant expense when you sell a property. However, there are ways to reduce the tax liability, including using certain expenses to offset realized gains.
A CGT Overview
If your property appreciated in value while you owned it, you’ll likely receive capital gains upon selling it. Specifically, the formula for calculating gains is:
Capital Gain=Sales Price−(Purchase Price+Capital Improvements−Depreciation Taken+Allowable Expenses)
While earning a profit on your investment can be worthwhile, it also triggers capital gains taxes. How much you pay depends on how long you owned the property.
If you held the asset for a year or less, gains are taxed based at the ordinary income tax rate, which depends on your bracket. If you owned the property for over a year, the gains are subjected to long-term capital gains tax, which ranges from 0% to 20%, based on your income bracket. However, real estate gains may be partially taxed at up to 25% due to depreciation recapture, and high-income earners may be subject to an additional 3.8% Net Investment Income Tax (NIIT).
Methods to Potentially Reduce Capital Gains
While you can expect to owe taxes on the profit when you sell your real estate, the IRS does allow certain deductions and expenses that could help reduce those gains.
Capital improvements
Certain improvements made may increase your cost basis, potentially reducing taxable capital gains when you sell. These include:
- New construction (remodels and room additions)
- Structural upgrades (roof replacements and foundation repairs)
- Energy conservation upgrades (attic insulation and solar panel installation)
Remember that routine maintenance and repairs, like painting or plumbing, aren’t considered capital expenses. Rather, these are maintenance expenses that have different tax treatments.
Selling expenses
When you sell the property, you incur costs that could be deducted from the sales proceeds, lowering the capital gains. The following are considered allowable expenses:
- Real estate agent commissions
- Advertising and marketing expenses
- Legal fees
- Staging costs
- Escrow and closing costs
- Mortgage prepayment penalties may be deductible as a separate expense on Schedule A (for personal use properties) or Schedule E (for rental properties).
Like-kind exchanges
You could defer capital gains from selling your investment property through a 1031 exchange. With this method, you use the proceeds to acquire a like-kind property of equal or greater value than the one you sold. Be aware that the like-kind exchange is complex, with multiple regulations.
Tax-loss harvesting
Applying capital losses from other investment sales to reduce your property’s capital gains is possible. Be aware of the rules that exist with this method. For example, long-term losses are applied to long-term gains, while short-term losses apply only to short-term gains.
Primary residence exclusion
You might not owe capital gains taxes if you used your investment property as a primary residence for at least two of the last five years. Under this rule, you could exclude between $250,000 to $500,000 of capital gains from taxation, depending on whether you’re a single or joint tax filer.
Partner with a Professional
There are ways in which you could possibly lower the taxes you owe on the gains generated from your property’s sale. When you do so, consult a tax advisor who is knowledgeable about property investments, capital gains, and legal requirements. Doing so could help reduce tax liabilities while keeping you on track to meet your investment goals.
If you’re considering using a 1031 exchange as part of a tax-advantaged strategy, contact the experts at Realized 1031. The professional staff has years of experience and knowledge about the ins and outs of like-kind exchanges. To learn more or to set up a free portfolio analysis, visit the website at realized1031.com.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
