How to avoid the capital gains tax: primary vs investment property

As we all know, real estate appreciates over time. What you might not know is that you actually have to pay taxes on the profit you made from the sale of your home. If you bought your property for $200k, and you sold it today for $500k, you would be taxed on that $300k profit. This is called a capital gains tax.

However, there are simple ways to get around paying those taxes (or at least a portion of them)! The first rule is to own your property for at least one year. If you sell your property less than a year from when you bought it, then it is considered a short term capital gain, and could be taxed up to 37%, depending on your tax bracket.

The next rule depends on the type of property that you are selling. If you are selling your primary residence, then you could qualify for a $250k exemption, or $500k exemption if you’re married filing jointly. This is called the Section 121 exclusion. To qualify for this exemption you must meet the ownership and the use requirements: you must have owned and lived in the house for at least 2 of the last 5 years prior to its sale. The 2 years do not even have to be consecutive. However, if you have used this exclusion on the sale of another property in the last 2 years, you might not qualify.

p.s. you still have to report the sale on your income taxes that year, even if the exemption covered the entire profit!

If you’re selling an investment/rental property, then unfortunately, you cannot qualify for that exemption. However, if you’re planning on buying another investment property after you sell the first one, then there is a way to defer those taxes!

A 1031 exchange allows you to use the money from the sale of one investment property to buy another investment property, without having to pay capital gains taxes…for now.

For a 1031 to work, you have 45 days from the sale of one investment property to identify your next purchase, and then 180 days to actually close on that identified property, avoiding any capital gains taxes! You would hire a 3rd party company to facilitate this exchange.

However, you can’t avoid paying those taxes forever. When you sell that next property, you’ll have to pay the taxes.

You might be wondering, then whats the point??

Most people utilize the 1031 exchange for their heirs. Capital gains taxes don’t get passed on to your kids when you pass, but the property does! So this is really a way to start building generational wealth for you future children and grandchildren.

Interested in getting started in real estate investing? I’d love to chat!

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