If the real estate you own increases in value and you want to sell it to reap the profits. Doing so results in capital gains, which is positive. What’s not so positive are the capital gains taxes you might owe.
Understanding these terms can help you make informed decisions about what steps you want to take with your real estate. This understanding can also assist you with creating a tax-advantaged plan by taking steps to defer those capital gains.
Defining Capital Gains
You paid a certain amount to buy your real estate, and you might also have paid extra for capital improvements. The purchase price and capital expenditures equal a concept known as the adjusted basis.
After owning the real estate, you put it on the market. To your delight, the asset sells for much more than its adjusted basis. The difference between that adjusted basis and the amount you received from the sale is the capital gains.
Capital gains can be a significant source of investment returns. They can also generate a substantial amount of taxes.
Explaining Capital Gains Taxes
Capital gains taxes are what you owe to the IRS and, if required, to your state for the profit generated by your real estate sale. How much you owe depends on how long you owned the real estate asset:
Short-term capital gains: occur if you sell an asset held for less than one year. The gains are considered ordinary income and are taxed as such. Your tax bracket determines how much you pay.
Long-term capital gains: occur if you sell an asset held for one year or longer. The profits are taxed at the capital gains rate, which can range from 0% to 20%, depending on your tax bracket. In most cases, the capital gains tax rate is 15%.
Tax-Advantaged Strategies
If you know your real estate asset appreciated during your ownership, you might consider the following strategies to defer capital gains taxes:
1031 Exchange: Through the like-kind exchange, you could sell your real estate (as long as it was used for investment or business purposes) and direct the proceeds into similar real estate of greater or equal value. A properly executed exchange could help defer capital gains taxes.
Opportunity Zones: Created as part of the Tax Cuts and Jobs Act of 2017, the Opportunity Zone program allows you to invest your capital gains into a Qualified Opportunity Fund (QOF). The QOF pools your funds with those of other investments, which are then directed to federally designated, economically underperforming Qualified Opportunity Zones (QOZs). This method could help you defer capital gains taxes until Dec. 31, 2026.
Primary Residence Exclusion: If your real estate was used as the primary residence for at least two of the last five years, you could exclude a certain amount of capital gains from taxation. The first $250,000 from the sale can be excluded from taxes if you're a single filer. The exclusion amount is $500,000 for married couples.
Tax-loss harvesting: You could apply capital losses from selling other assets to offset taxable gains. You could offset up to $3,000 of your ordinary income through the process. However, long-term losses apply to long-term gains, while short-term losses are used to offset short-term gains. Furthermore, “wash-sale” rules apply, meaning you can’t sell the asset at a loss and then turn around and buy an identical asset within 30 days of the sale.
Understanding Gains and Taxes
Capital gains can represent good news. They also mean you’ll pay taxes. Knowing what you owe and the best strategy to minimize losses can help you get a handle on your investment goals.
We presented a brief overview of many alternatives available. Contact the professionals of Realized 1031. The staff has decades of experience and can help guide you through alternatives you might consider.
For a no-obligation 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.
