How To Avoid Or Reduce Your Capital Gains Tax For Real Estate
There are ways a homeowner or investor can reduce their capital gains tax when selling real estate. To help reduce what you owe:
1. Satisfy The 2-In-5-Year Requirement
If you lived in the home for at least 2 years out of the last 5 years and used it as your primary residence, you meet the residence requirement. The 24 months can be spread out over the 5-year period and don’t have to be continuous – the key is reaching a total of 24 months (730 days) of residence within that timeframe.
2. Qualify For An Exemption
Remember, there are several specific situations that may qualify for an exemption, such as:
- The home was a primary residence and the homeowner made less than $250,000 in profit and is doing their taxes as a single filer.
- The home was a primary residence and the homeowner made less than $500,000 in profit and is married, filing jointly.
- If the home was sold because of work or an unforeseen circumstance, the IRS might allow an exemption.
- The homeowner is a member of the U.S. Military and had their service extended.
3. Adjust Your Cost Basis
The cost basis in real estate serves as the original value that a buyer pays for a property. Here’s the simple math problem you can use to figure out your cost basis:
The Purchase Price (including any closing costs) + Capital Improvements = Cost Basis
You may need to pay capital gains tax on any profit you generate above and beyond what you initially paid for your property, and the cost basis determines what you’ll have to pay in tax when you sell your property.
4. Do A 1031 Exchange
A 1031 exchange allows you to sell an investment or business property and buy another without paying capital gains taxes. The exchange must meet IRS rules and be a like-kind property, which means a property of the same nature. In other words, you trade one real estate investment for another.
However, it’s important to note that you defer capital gains taxes – you don’t get out of them completely. If there are capital gains when you sell your final real estate investment, and you’re not doing another 1031 exchange, you will have to pay capital gains tax.
5. Convert The Home Into A Primary Residence
A seller can convert a home into a primary residence before selling the property to help avoid the capital gains tax. For instance, if you had a vacation home – where you only spent summers – you could sell your primary residence and move into your vacation home. A scenario like this may qualify you for the capital gains exemption.
Note that if you sell a rental property, you’ll have to pay a capital gains tax on any profit you earn from the sale.