As business investors, we are all hoping to make a tidy profit. But when it comes to selling investment property, we must be mindful of the capital gain tax that the government will collect on any profits we make. Depending on the size of those profits, this tax can bite off a hefty chunk of our earnings - anywhere from 10% to 37%. Fortunately, there are some legal strategies you can use to reduce or eliminate this tax altogether. We will look at some of these tactics and show you how you can protect your investment property from excessive capital gains taxes.
1. Use a 1031 Tax Deferred Exchange
Want to defer capital gains taxes? Section 1031 of the US tax code is the way to go. This rule lets you sell your investment property and use the proceeds to buy a property of the same or higher value without paying capital gains taxes on the property sold. Simple, right? Just keep in mind these important rules:
- Only investment real estate properties qualify for Section 1031. Not your primary or vacation home.
- You have 45 days after selling your property to find up to three like-kind properties.
- Your new property must be closed before your tax return is due or 180 days after selling your old property.
It is important to follow these guidelines -- missing a step will disqualify you from using Section 1031. So, if you're looking to manage your taxes better, keep Section 1031 in mind.
2. Use the IRS Section 121 Primary Residence Exclusion
You can reduce your capital gains taxes on residential properties by taking advantage of the Section 121 exclusion. As a single individual, you can exclude up to $250,000, and as a married couple, up to $500,000. To qualify, the property must have been your primary residence for at least two of the past five years leading up to its sale while you owned it. Keep in mind, this tax reduction strategy is not available for investors with multiple investment properties on the market simultaneously.
3. Short-Term and Long-Term Capital Gains Differences
If you plan on selling an investment property within a year, be aware that the government considers any profits made as short-term capital gains which are subject to a high tax rate of up to 38%. However, if you hold onto the property for a longer period, any profits made will be classified as long-term capital gains and taxed at a lower rate of around 10%. To take advantage of this reduced tax rate, it is important to hold onto your investment properties for an extended period.
Do not let capital gains taxes eat into your investment property profits! With some smart strategies, you can reduce and defer these payments. And for even more expert guidance, consider teaming up with a tax professional. Keep more of your hard-earned money where it belongs – in your bank account!
