As a homeowner or a real estate investor, you may be required to pay capital gains tax after selling your property. While paying taxes is a responsible thing to do, sometimes it may not work in your favor.
Avoid Capital Gains Tax
However, there are instances where capitals gains when selling a house may not affect you, and you can use some legal strategies to avoid capital gains.
1031 exchange is a popular strategy to avoid capital gains taxes on real estate. It allows you to sell a house, use the money to invest in another property, and postpone the taxes until you sell the home. Most importantly, when you sell the new house, you can leverage another 1031 exchange and indefinitely defer capital gains tax until you’re ready to pay.
However, you need to learn much about the strategy, and you might want to talk to a professional before filing a 1031 exchange.
While SDIRAs won’t offer any tax relief for real estate investments you already own, it’s possible to avoid future capital gains by ensuring your real estate ownership is within a retirement account.
Most people think of IRA accounts as tools that help you buy mutual funds, stocks, and exchange-traded funds. There are also some special accounts known as SDIRAs that help you invest in other types of assets like real estate.
The good thing about SDIRAs is that real estate assets you hold in the accounts are not subject to capital gains tax. In addition, rental income from your properties is not taxable. Regardless of how much profits your real estate makes, you don’t pay any taxes, but when you withdraw the amounts, the money is taxable.
Tax Loss Harvesting
If you have other investments that haven’t paid off, you can use the loss to offset your capital gains tax. For instance, if you may have acquired some stocks earlier and now they are worth less than what you paid. You can leverage the losing investment and create a capital loss to offset the capital gains when you sell a property.
To illustrate, if you have about $10,000 taxable capital gains from a real estate sale, and you sold your stocks at a $3,000 loss; you can use the loss to reduce the capital gains to $7,000. This method is known as tax-loss harvesting, and it’s an excellent way for investors to reduce capital gains tax.
Primary Residence Exclusions
In most cases, when you sell your primary residence, you don’t have to pay capital gains tax. The primary residence exclusion tax helps you to exclude up to $250,000 or $500,000 for couples.
However, this may not be very helpful if you are a real estate investor. Nevertheless, the IRS defines a primary residence as a house you’ve lived in for the last two years out of five years of ownership. It doesn’t say that you should have lived in the property since you bought it.
You can acquire a property and rent out for a few years, move in for two years before selling to avoid the capital gains tax.
Capital gains tax can be quite expensive when you sell a house –more so when the property wasn’t your principal residence. However, you can use the strategies here to avoid the hefty fees.