Ultimately, every landlord’s goal is to maximize their investments and expand their rental business. However, taxes, payments, and legal requirements can take up a large portion of investment profits, especially if you decide to sell a rental. Additionally, it’s considered a taxable capital gain when you sell a rental home for profit. Let’s go over how you can reduce capital gains tax.
What is Capital Gains Tax?
Whenever you invest in rental properties, it’s crucial to keep important tax information and liabilities in mind. After all, the IRS takes a cut of your income in the United States, including the assets that you sell for profit.
A capital gain is a profit from selling a property or investment. Once you sell an asset, you’ll pay capital gains taxes. The amount of time you’ve owned an asset before selling it affects taxes. Let’s go over the two different categories of capital gains and how the tax process works.
Long-term Capital Gains
Long-term capital gains are assets that are held for at least a year before being sold. These types of gains are taxed according to thresholds for taxable income at 0%, 15%, or 20%. However, the tax rate for most people who claim long-term capital gains is less than 15%.
Long-term capital gains are taxed lower than regular income or short-term gains because the government wants to encourage responsible investing behavior. So, if you buy a property and hold it for more than a year before you sell it, you’ll be taxed at a lower rate than if you sold it right away.
Short-term Capital Gains
It’s a short-term capital gain when you sell an asset within less than a year of owning it. These types of capital gains are taxed at the same rate as your normal income. For example, if you have $90,000 in taxable income from your salary and $15,000 from investments, your taxable income is $105,000. Additionally, short-term gains are subject to whatever tax bracket you fall under.
Keep in mind that capital gains are taxed depending on your income. However, a short-term gain could be taxed at a higher rate than your yearly earnings if it causes your income to jump to a higher tax bracket. There are currently seven United States federal tax brackets, ranging from 10% to 37%.
As you can see, capital gains have a significant impact on the total amount of profit you keep. Luckily, no matter what type of asset you’ve sold this year, there are a few ways to reduce capital gains tax.
How to Reduce Capital Gains Taxes on Your Investment Property
It can be hard to maximize your profits if you pay massive tax amounts for your sold assets. Investors know that they can either pay short-term gains or long-term gains when it comes to capital gains tax, so it’s up to them when they sell an investment.
But, is there any way to avoid paying capital gains tax? Let’s go over a few ways landlords can reduce capital gains tax.
- Buy Properties With Your Retirement Account
- Use Tax-loss Harvesting
- Make the Property a Primary Residence
- Use a 1031 Exchange
Buy Properties With Your Retirement Account
Avoid paying taxes on an investment property by using a retirement account to purchase it. Tax-deferred retirement accounts, including an IRA, Roth IRA, or a 401(k), allow investors to buy properties while accumulating rental income and capital gains tax-free until they make withdrawals.
Remember that you can only make investments with a retirement account if it’s a self-directed account. That said, most retirement accounts are not self-directed, in which case you cannot make real estate investments. Additionally, if you do use your retirement account to invest, you must put all proceeds from your investment back into the account.
Use Tax-Loss Harvesting
Another way you can avoid capital gains tax is by using tax-loss harvesting. Tax harvesting occurs when an investor sells one property at a loss to offset the gains of another property sold that year. That said, capital losses can offset any amount of capital gains. So, if you make $40,000 but lose $45,000, you wouldn’t have to pay capital gains tax on the $40,000 profit.
However, if your losses exceed your capital gains, you can also deduct up to $3,000 per year in capital losses if you are married, filing jointly. On the other hand, if you are filing single, you can deduct up to $1,500 in capital losses.
Make the Property a Primary Residence
Primary residences and rental properties have different capital gains and home sales taxes. However, you must meet specific requirements to convert a rental to a primary residence. For example, you have to own and use the property as a primary residence for at least two out of the five years before selling it. Additionally, suppose you used depreciation as a tax deduction for your rental property before converting it to a primary residence. In that case, you’ll have to recapture the deduction and pay a flat 25% tax on it.
Overall, suppose you qualify for converting a rental property to a primary residence before selling it. In that case, you can exclude up to $250,000 if you file single and $500,000 if you are married filing jointly.
Use a 1031 Exchange
Finally, using a 1031 exchange can reduce capital gains tax. Section 1031 of the tax code lets investors sell a rental property to help buy another like-kind property, known as a replacement property. First, however, you must follow the rules and buy a property that is similar in type and nature to the one you sold.
Additionally, you have a limited time to purchase another property after selling the original one. In fact, you should find another property to buy within 45 days. Then, close on the sale within 180 days of selling your old property. That said, it’s essential to keep in mind that if you miss the deadline to purchase another property, you’ll have to pay total capital gains taxes on the original property sale.
How Can You Lower Your Taxable Income?
Lowering your taxable income can help you save money during tax time. Luckily, there are several ways for investors to lower their taxable income. Here are some of the most common methods.
- Save for Retirement – When you put significant amounts of money towards your retirement, you can lower your taxable income. Employer-Sponsored Plan or an Individual Retirement Account (IRA) can help reduce taxable income in the tax year of a contribution.
- Take Business Deductions – Deducting business costs is a great way for full or part-time self-employed taxpayers to lower taxable income. Consider several deductions, including home office costs, travel costs, and other business expenses, including residential property management in Northern Virginia.
- Tax-loss Harvest Investments – As mentioned earlier, a good way to lower your taxable income is by tax-loss harvesting investments.
Maximize Your Rental Business With Property Management
Owning one or more rental properties can lead to an endless string of tasks for landlords. Luckily, landlords don’t have to manage it all alone. Instead, Professional Property Management in Northern Virginia has the best rental management professionals and experts to help you out.
Whether you need help with tenant screening, maintenance, rent collection, or eviction services, Professional Property Management is eager to help you succeed. Contact us today if you need rental management services in Northern Virginia.