Capital gains happen after the fact. They are the result of deductions that have already been made. Reducing capital gains must start before arriving at a capital gains figure. In this article, we’ll see how to reduce capital gains, which will, in turn, reduce taxable income.
How Do We Arrive At Capital Gains?
Capital gains are profits on capital assets. These gains are realized at the time of sale. Capital assets include a home, stocks, bonds, investment property, and the sale of a capital asset within a business. Operating expenses can be deducted from profits on a business, such as an investment property. This reduces the potential taxable income. What’s left is a capital gain.
It’s also the same for a home. Improvements to the home and costs incurred at the time of sale can be deducted. All will reduce the capital gain on the sale.
Reducing Capital Gains
Capital gains come in two varieties — short-term and long-term. Short-term capital gains are taxed at your ordinary income tax rate. Long-term capital gains max out at 20%. Holding a capital asset for more than a year results in a long-term capital gain when the asset is sold. So, you can reduce capital gains by holding the asset for longer than a year.
If you are selling a home or an investment property, some expenses can help reduce taxable income. The deductible expense depends on the asset. There are no expenses to deduct for assets such as stocks and bonds. Any profit is considered a capital gain, which can be offset with stock/bond losses.
On a primary residence, there is a fairly long list of expenses that can reduce potential capital gains:
- Qualified home improvements
- Realtor commissions
- Transfer tax
- Recording fees
- Title insurance
- Title service fees
- Attorney fees
The sale of an investment property may also have the same expenses plus operating costs. Because an investment property is a business, it is able to reduce taxable income through operating costs. These costs don’t directly affect capital gains but can reduce the overall tax bill for the year the property is sold.
Investment property business expenses include:
- Interest (mortgage and loans)
- Repairs
- Employees
- Insurance
- Professional or legal services
Of course, depreciation during the current year can be taken, but depreciation recapture must also be factored in.
Real estate tax deductions can be complex. That’s why working with a tax specialist who is fluent in real estate is important.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
The income stream and depreciation schedule for any investment property may affect the property owner's income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
