Complete Guide to Capital Gains Tax on Real Estate

The goal of real estate investing is to generate returns and grow your wealth. Strategies such as flipping houses can result in a large return on investment after the sale of the property. However, capital gains tax on real estate can eat into a large portion of that return.

Capital gains tax can reduce the profit investors and homeowners make from selling a property. Luckily, some strategies can reduce your overall capital gains so you owe less in taxes.

What Are Capital Gains?

Capital gains are the profit an individual makes from the sale of an investment or asset, such as real estate, stocks and bonds, art, cars and more. The IRS considers it a taxable event when these assets are sold for a higher price than when they were purchased.

There are two types of capital gains: long-term and short-term. Short-term investments are held for under a year before they are sold and are taxed as regular income. Long-term investments are held for over a year and fall within the long-term capital gains tax bracket.

How to Calculate Capital Gains Taxes

To determine how much you’ll owe in capital gains tax on real estate, first consider how long you owned the property. If you owned it for more than a year, it will be taxed as long-term capital gains. Otherwise, it’ll be taxed as regular income. Next, you’ll need to consider your taxable income and filing status. This will help you calculate capital gains tax.

Investors will have a 0% capital gains tax rate if their taxable income is:

• $44,625 or less and are single and married, filing separately
• $89,250 or less and are married, filing jointly
• $59,750 or less and are head of household

Investors will have a 15% capital gains tax rate if their taxable income is:

• more than $44,625 up to $492,300 and are single, filing separately
• more than $44,625 up to $276,900 and are married, filing separately
• more than $89,250 up to $553,850 and are married, filing jointly
• more than $59,750 up to $523,050 and are the head of the household

Anything over these amounts will be taxed at the maximum of 20%.

Next, you’ll need to determine your capital gains. Here is a step-by-step guide to determining your taxable capital gains.

1. Add the purchase price, plus any closing costs and necessary renovations. This is the amount of money you invested into the asset. The sum of these expenses is the basis.
2. Deduct the basis from the sale price. The difference is your capital gain.
3. Use the above tax rates to determine your capital gains tax rate. Then multiply your capital gains by the tax rate.

Long-Term Capital Gains Taxes

Long-term capital gains are profits generated from the sale of an asset that was held for a year or longer. Real estate investors who have owned the asset for more than a year will be taxed at favorable long-term capital gains rates. Long-term capital gains taxes tend to be lower than standard income tax rates, which leads to more profit in your pocket.

Capital gains from long-term assets also qualify for more personal exemptions. These exemptions lower the amount that qualifies for capital gains tax. Exemptions include the sale of primary residence, moves because of health or work and unforeseeable events. Upon selling a property, research all exemptions to save as much money as possible.

Short-Term Capital Gains Taxes

Profit from assets held for less than a year is considered short-term capital gains. Short-term capital gains taxes are taxed as ordinary income. The 2024 income tax brackets are:

If the real estate you are selling results in short-term capital gains, they will be added to your ordinary income. Depending on the amount, this may result in you being placed in higher tax brackets. Long-term capital gains rates are preferable, so you may want to hold your assets for longer than a year. If you can’t, ensure you plan ahead and calculate your tax bracket so you don’t end up with an unexpected tax bill.

How to Lower Capital Gains Taxes on Real Estate

Getting a good return on investment is exciting until you have to pay your capital gains tax. Taxes can eat into your profit significantly. A few strategies can offset this bill, such as qualifying for exemptions or allocating the gains to a new property.

Make the Property Your Home for at Least Two Years

The sale of primary residences gets a large exemption from capital gains tax. To qualify for the primary residence exclusion, the property you are selling must have been your primary residence for at least two years (730 days) within the past five years. These 24 months do not have to be within a single block of time.

If the real estate qualifies as your primary residence, the first $250,000 of the sale is exempt from capital gains for investors who file as single taxpayers. For married couples filing jointly, the first $500,000 is exempt as long as both members of the couple meet the residency requirements. This exemption can lead to substantial savings when tax season comes around.

Qualify for Exemptions

In addition to primary residence exemptions, several other situations qualify for a full or partial exemption. Service, intelligence and Peace Corps individuals can suspend the five years for up to 10 years if they were on qualified extended duty. This means they can get the primary residence exclusion, even if they didn’t live at the property for two years within the past five years as long as the home was their primary residence during a five-year period that ended within the past 10 years.

If an earlier home was condemned or destroyed, you may be able to count your residency there toward the sale of your new home. If it totals two years, you may qualify for the exemption. Additionally, if you had to relocate for work, you may qualify for a partial exemption. To qualify, your new job location needs to be 50 miles farther from your home than your previous job location or be 50 miles from your home if you had no previous job location.

If you moved to obtain healthcare or provide care for a family member, you also may qualify for a partial exemption. Other unforeseeable events, such as your home being destroyed, divorce or suffering a casualty loss may result in a partial exemption.

Invest the Sale Proceeds into a New Property

Another way to offset capital gains is a 1031 exchange. In this transaction, investors take the profit from the sale of one property and use it to purchase another property. Any gains used to purchase another property are exempt from capital gains tax. This can help lower your tax rate on long-term gains or postpone them entirely. This is a great strategy for investors who buy properties solely for investment purposes and don’t qualify for primary residence exemptions. Primary residences do not qualify for 1031 exchanges.

Set Off Capital Gains with Capital Losses

If you hold other investments and experience capital loss on other assets, that loss can be used to offset capital gains. For example, if you sold one property at a loss of $50,000 but another with a profit of $150,000, your capital losses would be deducted from your gain. Only $100,000 would be eligible for capital gains tax.

This strategy can lower your long-term capital gains tax bracket and decrease the amount you owe. And if you experience more capital loss than gain within a year, losses that exceed $3,000 can be carried forward into the following year until the amount is exhausted. Businesses can also use this strategy to offset capital gains tax for years the business performs well.

Reduce Capital Gains Tax by Planning Ahead

A tax bill can dampen the thrill of selling a successful real estate investment. It can also lower your overall portfolio’s worth and impact progress toward financial goals. However, there are many strategies to decrease your capital gains taxes that savvy investors have been using for years.

By doing your research and planning, you could decrease your capital gains tax significantly. If you have any questions about what exemptions you qualify for, speak to your financial adviser.

Frequently Asked Questions