Capital Gains Tax on Real Estate: How it Works and How to Avoid it

Capital gains is the difference between the purchase price and the selling price. When you buy an asset for $10, and sell it for $15, the government wants a cut of the $5 you made. That’s capital gains tax. With proper planning, homeowners can reduce their capital gains tax or even avoid it entirely (legally of course).

How Much Am I Taxed for Capital Gains?

Short-term capital gains on real estate held for one year or less are taxed at ordinary income tax rates, up to 37%. Long-term capital gains on real estate held for more than one year benefit from lower federal tax rates of 0%, 15%, or 20%, depending on the taxpayer's income. Note that state capital gains tax varies widely from 0% in states like Florida and Texas to 13.3% in California.

🤑 0% tax rate in some states for taxable income below $44,625 for single filers and below $89,250 for married couples filing jointly.

How Capital Gains Tax Applies to Home Sales

Capital gains tax on home sales is calculated by subtracting the property's adjusted cost basis (purchase price plus improvements and associated costs) from the selling price. If a homeowner sells their primary residence, they can exclude up to $250,000 of the gain ($500,000 for married couples filing jointly) from taxation, provided they have lived in the home for at least two of the last five years. For example, if you sell a vacation home or rental property, the full capital gain is usually taxable. Understanding these rules helps homeowners maximize exclusions and minimize tax liabilities.

🤑 Include home improvement costs to the purchase price for a lower taxable capital gain

🤑 Exclude $250,000 of the taxable gain or $500,000 for married couples if you lived in the home two of the last five years

1031 Exchange for Real Estate Investments

A 1031 exchange allows real estate investors to defer capital gains tax by reinvesting the proceeds from the sale of an investment property into another similar property. This deferral strategy can help investors grow their real estate portfolios without immediate tax consequences.

🤑 Defer your capital gains tax by re-investing all the gains from your first property into a new property

Tax Loss Harvesting

Tax-loss harvesting involves selling investments at a loss to offset capital gains from other investments, thereby reducing the overall taxable gain for the year. This strategy can help balance out gains and losses within a portfolio, minimizing the capital gains tax liability.

🤑 If you have a portfolio of investments, sell some at a loss to offset capital gains from your real estate

Conclusion

Always consult with a tax professional to tailor these strategies to your unique situation, ensuring compliance with both federal and state tax laws. Properly managing your real estate transactions can lead to substantial savings and more favorable financial outcomes