Guide: How to Avoid Capital Gains Tax on Real Estate (2024)

Guide: How to Avoid Capital Gains Tax on Real Estate (1)

Federal capital gains taxes as high as 37% can significantly cut into your real estate profits. Learn how to avoid capital gains taxes on real estate, including what exemptions you might already be eligible to receive. Find out how you can also qualify to reinvest your real estate profits to defer your capital gains taxes in this guide: How to avoid capital gains tax on real estate.

Key Takeaways on Avoiding Capital Gains Tax

  • Understanding Capital Gains Tax: Capital gains taxes are fees that real estate investors must pay after selling a property. They are calculated based on the profit made from the sale, i.e., the difference between the purchase price and the selling price of the real estate​.
  • Who Pays Capital Gains Tax: The IRS requires payment of capital gains tax upon selling an asset under certain conditions. These include scenarios where the property is a second home (investment, vacation, or rental), when the property has been owned for less than two years within a five-year period, or when the home was lived in for less than two years in the five years before selling. The specific rate depends on various factors such as income tax bracket, marital status, duration of property ownership, and whether it was a primary or secondary residence​​.
  • Avoiding Capital Gains Tax: Strategies to avoid or reduce capital gains tax on real estate include waiting at least a year before selling a property (qualifying for long-term capital gains), taking advantage of primary residence exclusions, rolling profits into a new investment via a 1031 exchange, itemizing expenses, choosing properties in opportunity zones, and timing the sale of the property for a period when income is lowest​​.
  • Deferring Capital Gains Tax: Buying another home after selling an investment property within 180 days can defer capital gains taxes. Although reinvesting the proceeds from a sale still obligates the payment of capital gains, it can defer them. Taxes cannot be completely avoided by reinvesting in real estate, but they can be deferred by investing in similar real estate property​1.
  • The Two-Out-of-Five-Year Rule: According to this rule, one doesn’t need to live in a home for five consecutive years to qualify for tax exemptions. Living in a home cumulatively for two out of the five years before selling can qualify one for capital gains tax exclusions of $250,000 per person or $500,000 per couple​​.

What Are Capital Gains Taxes, and How Do They Work?

Before we get into tips to avoid capital gains taxes on real estate, let’s review what they are and how they work. Capital gains taxes are fees real estate investors must pay after selling a property. Real estate investors pay a tax on the profits they receive selling property or land, similar to paying taxes on earned income.

The Internal Revenue Service calculates capital gains based on profit. This typically involves being taxed on the difference between how much you paid for the real estate versus how much you receive after selling it.

Who Pays Capital Gains Taxes?

The IRS requires you to pay capital gains taxes anytime you sell an asset. The federal government requires sellers to pay capital gains if:

  • The home was a second property (investment, vacation, or rental)
  • You owned the home for less than two years within a five-year period
  • You lived in the home for less than two years in the five years before selling
  • You have already claimed your exemption on another property within the last two years
  • You buy the property through a 1031 exchange

The specific rate you pay depends on your income tax bracket, marital status, how long you’ve owned the property, and whether it was your primary or secondary residence. You can get an exemption if you sell your primary residence but can only claim it once every two years.

How To Avoid Capital Gains Tax on Real Estate

Capital gains taxes can quickly cut into your real estate profits. If you plan to buy and sell several properties for profit, you’ll want to consider how to avoid capital gains tax on real estate.

A few techniques can help you avoid expensive capital gains, including:

  • Wait before selling: Buying and selling a property within a year is considered a short-term capital gain. Waiting at least a year before selling, if you can manage the monthly costs, can help reduce your tax liabilities by qualifying you for long-term capital gains.
  • Take advantage of primary residence exclusions: All states offer exemptions on tax liability when selling your primary residence. To qualify, you must own and reside on the property for a specified time. If you can improve its value while living on-site, you might qualify for a $250,000 (single) or $500,000 (married) exemption.
  • Roll your profits into a new investment: A 1031 exchange allows you to roll your real estate profits into a similar investment type. However, the requirements for a 1031 exchange are often more in-depth than your other options. A 1031 tax-deferred exchange might also be an option if you’re selling real estate at a loss.
  • Itemize your expenses: Itemizing your expenses, including construction, equipment, repairs, and sale costs, can help you decrease your tax liability. You’re only required to pay capital gains on your profits.
  • Strategically plan where to buy: Strategically choosing properties in opportunity zones can help you manage capital gains costs. These zones are often distressed areas that could use improvements, so you can do good for the local community while also reducing your out-of-pocket costs.
  • Choose your sale date carefully: Timing the sale of your property for a period when your income is at its lowest can also help you avoid capital gains taxes. The IRS charges as little as 0% on capital gains if your income is lower than $80,000.

Considering these options before choosing a property and creating a timeline can help you manage your tax liabilities. Combining multiple strategies, such as buying in an opportunity zone and timing your sale wisely, can help you keep more profits in your pockets.

Frequently Asked Questions about Capital Gains Tax

Guide: How to Avoid Capital Gains Tax on Real Estate (2)

How Long Do I Have to Buy Another House to Avoid Capital Gains?

You might be able to defer capital gains by buying another home. As long as you sell your first investment property and apply your profits to the purchase of a new investment property within 180 days, you can defer taxes. You might have to place your funds in an escrow account to qualify.

Do I Pay Capital Gains if I Reinvest the Proceeds From the Sale?

While you’ll still be obligated to pay capital gains after reinvesting proceeds from a sale, you can defer them. Reinvesting in a similar real estate investment property defers your earnings as well as your tax liabilities.

Can You Avoid Capital Gains Tax by Reinvesting in Real Estate?

You can’t avoid capital taxes by reinvesting in real estate. You can, however, defer your capital gains taxes by investing in similar real estate property.

What Is the Two-Out-of-Five-Year Rule?

The two-out-of-five-year rule means you don’t have to live in a home for five consecutive years to qualify for tax exemptions. As long as you live in a home cumulatively for two out of the five years before selling, you might qualify for capital gains tax exclusions of $250,000 per person or $500,000 per married couple.

What Is the Difference Between Short and Long-Term Capital Gains?

Capital gains taxes range between 0% and 37%. The average capital gains rate is lower for long-term gains than short-term. A short-term capital gain includes buying, selling, and earning profits on an asset you have owned for a year or less. A long-term capital gain is a profit from an investment you have owned for more than a year. Therefore, waiting to sell your real estate asset could save you money.

Want to discuss the tips in this guide: How to avoid capital gains tax on real estate in detail? Do you have more questions about your capital gains tax liabilities before buying or selling a real estate asset? Contact us at Anderson Legal, Business, and Tax Advisors for your free strategy session today.

Guide: How to Avoid Capital Gains Tax on Real Estate (2024)

FAQs

Guide: How to Avoid Capital Gains Tax on Real Estate? ›

You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.

What is a simple trick for avoiding capital gains tax on real estate investments? ›

A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.

Is there a capital gains loophole for real estate? ›

When does capital gains tax not apply? If you have lived in a home as your primary residence for two out of the five years preceding the home's sale, the IRS lets you exempt $250,000 in profit, or $500,000 if married and filing jointly, from capital gains taxes.

What are the two rules of exclusion on capital gains for homeowners? ›

Sale of your principal residence. We conform to the IRS rules and allow you to exclude, up to a certain amount, the gain you make on the sale of your home. You may take an exclusion if you owned and used the home for at least 2 out of 5 years. In addition, you may only have one home at a time.

How to lower capital gains tax on property? ›

Here are a few:
  1. Offset your capital gains with capital losses. ...
  2. Use the Internal Revenue Service (IRS) primary residence exclusion, if you qualify. ...
  3. If the home is a rental or investment property, use a 1031 exchange to roll the proceeds from the sale of that property into a like investment within 180 days.13.

Are there any loopholes for capital gains tax? ›

Internal Revenue Code section 1031 provides a way to defer the capital gains tax on the profit you make on the sale of a rental property by rolling the proceeds of the sale into a new property.

At what age do you not pay capital gains? ›

Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.

Do I have to buy another house to avoid capital gains? ›

How Long Do I Have to Buy Another House to Avoid Capital Gains? You might be able to defer capital gains by buying another home. As long as you sell your first investment property and apply your profits to the purchase of a new investment property within 180 days, you can defer taxes.

Do you have to pay capital gains after age 70? ›

As of 2022, for a single filer aged 65 or older, if their total income is less than $40,000 (or $80,000 for couples), they don't owe any long-term capital gains tax. On the higher end, if a senior's income surpasses $441,450 (or $496,600 for couples), they'd be in the 20% long-term capital gains tax bracket.

How long after you sell a house do you have to reinvest the money? ›

In order to take advantage of this tax loophole, you'll need to reinvest the proceeds from your home's sale into the purchase of another “qualifying” property. This reinvestment must be made quickly: If you wait longer than 45 days before purchasing a new property, you won't qualify for the tax break.

Is $500 000 lifetime capital gains exempt? ›

Not All Gain Is Taxable

There is an exclusion on capital gains up to $250,000, or $500,000 for married taxpayers, on the gain from the sale of your main home. That exclusion is available to all qualifying taxpayers—no matter your age—who have owned and lived in their home for two of the five years before the sale.

How much gain can you exclude from a sale of a home? ›

The Bottom Line. You have to report any profits that result from the sale of your home. But the IRS allows you to exclude a certain portion of those gains—up to $250,000 if you're a single filer or up to $500,000 for married couples who file jointly.

Can mortgage payoff be deducted from capital gains? ›

A mortgage doesn't directly impact capital gains. However, homeowners who have a qualified mortgage and itemize their deductions are able to deduct mortgage interest annually. Once the home is sold, there isn't anything in the mortgage that impacts capital gains.

Do I have to pay capital gains tax immediately? ›

It is generally paid when your taxes are filed for the given tax year, not immediately upon selling an asset. Working with a financial advisor can help optimize your investment portfolio to minimize capital gains tax.

What is the 2 out of 5 year rule? ›

When selling a primary residence property, capital gains from the sale can be deducted from the seller's owed taxes if the seller has lived in the property themselves for at least 2 of the previous 5 years leading up to the sale. That is the 2-out-of-5-years rule, in short.

Can I sell stock and reinvest without paying capital gains? ›

With some investments, you can reinvest proceeds to avoid capital gains, but for stock owned in regular taxable accounts, no such provision applies, and you'll pay capital gains taxes according to how long you held your investment.

Do house flippers pay capital gains? ›

Long-term capital gains taxes are for assets held over a year and are charged at a more favorable rate, ranging from 0% – 20% depending on the bracket. House flippers are mostly going to fall into the camp of short-term capital gains.

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Dong Thiel

Last Updated:

Views: 6020

Rating: 4.9 / 5 (59 voted)

Reviews: 82% of readers found this page helpful

Author information

Name: Dong Thiel

Birthday: 2001-07-14

Address: 2865 Kasha Unions, West Corrinne, AK 05708-1071

Phone: +3512198379449

Job: Design Planner

Hobby: Graffiti, Foreign language learning, Gambling, Metalworking, Rowing, Sculling, Sewing

Introduction: My name is Dong Thiel, I am a brainy, happy, tasty, lively, splendid, talented, cooperative person who loves writing and wants to share my knowledge and understanding with you.