5 Ways To Offset Capital Gains On Real Estate

Investing in real estate can be a great choice for those looking to make money or grow wealth. However, any profits made from selling real estate investments may be subject to the IRS capital gains tax. Depending on how long they held onto the property, rates up to 20% may have to be paid. Rates differ between residential and commercial properties. But, there are methods of reducing tax liabilities. Knowing these strategies and taking advantage of them is key to paying less tax than needed when selling a property investment.

This guide will explain how investors can offset their capital gains when selling real estate investments. It will look at both common and complex strategies, utilizing tax-advantaged accounts, credits, and deductions from the IRS code.

Tax Strategies

Selling real estate? You could be responsible for capital gains tax. But don't worry! There are tactics to help reduce it. Here we'll look at the common methods to offset capital gains on real estate.

Make use of tax-deferred exchanges

Under §1031 of the IRS Code, real estate investors can delay capital gains taxes. They do this by swapping out their existing property for a "like-kind" one, such as an investment rental property. The exchange must take place within 180 days.

There are some rules to consider:

• The deeds must be the same type.

• Up to three replacement properties can be swapped without specifying which one.

• Exchange monies are held in escrow until used as a down payment or closing costs.

• Properties must adhere to like-kind standards in §1031.

• Any remaining equity can be rolled over into qualified retirement accounts or Roth IRAs. This is according to §408A of the U.S. Tax Code.

Deduct capital losses

Reducing taxes by using capital losses to offset capital gains is a key strategy for investors. It's simple but there are important points to consider. When you sell an asset and make a profit – a capital gain – you must pay taxes on it. But, losses from other investments can reduce the taxable income by deducting the loss from the profit of the sale.

The IRS allows deductions of up to $3,000 in net losses per year; extra losses can be carried over into the following year. To claim deductions for real estate losses, assets must meet certain criteria. They must be held as a long-term investment (more than one year) and be classified as "capital assets". This excludes personal use property such as jewelry, collectibles, and second homes.

Once these criteria are met, according to IRS regulations, taxpayers may claim deductions for net losses incurred due to sales. Investors may use any overall net loss between profits to manage their wealth, and avoid higher taxes when filing returns.

Utilize the 1031 exchange

The 1031 exchange is a way to ease the tax burden on capital gains from real estate sales. This allows an investor to delay paying taxes by trading a property for another "like-kind" one of equal or greater value. The capital gain can be held off until the new property is sold.

To use the 1031 exchange, special rules have to be followed. A qualified intermediary must look after the money from both ends and take care of all the paperwork related to real estate. If more than one like-kind property is acquired, it must be identified within 45 days of the original sale. Additionally, the properties must be for investment only. No personal use is allowed.

Tax savings can add up over time by using this IRS method. It is important to get help from experienced professionals who can guide you and make sure you meet all deadlines and paperwork requirements set by federal regulations.

Take advantage of the stepped-up basis

The stepped-up basis is a tax loophole that lets you adjust the taxable value of your property when you sell after an inheritance. Taking advantage of it could reduce or even eliminate capital gains taxes on your real estate.

If you inherit property, there are no capital gains taxes due as long as you sell within one year of the owner's passing. This also applies to married couples in community property states who've chosen different beneficiaries for their separate property.

Likewise, if you sell a home bought within one year, the stepped-up basis lets you adjust the taxable value to 100% of its market value on the date of purchase - not the original purchase price.

Plus, if multiple people purchased or inherited real estate together, then decide to separate, an agreed schedule can be drawn up. That way, each person gets income that isn't taxed, based on assets received higher than what they paid for. This spreads risk and lowers potential tax liabilities!

Take advantage of the $250,000/$500,000 exclusion

The IRS grants married couples an exclusion of up to $500,000 from the gain on the sale of their primary home. This is given if they have lived in the house for two of the last five years and haven't used the exclusion in the last two years. For single people, the exclusion is capped at $250,000.

Form 8949 and Schedules D should be filled out when filing taxes. This can be a great way to reduce capital gains. Up to $500,000 for married couples and $250,000 for single folks can be excluded from taxation.

Qualifications must be met to take advantage of this exclusion. Ownership and occupancy must have been for 24 months out of the past 5 years. Also, this exclusion cannot be taken within the past 2 years. Taxpayers over age 55 can qualify for additional reduced rates with certain criteria, such as being able to exclude up to $125,000 per person. It is also possible to qualify for state-level exclusions in some circumstances.

Check with a tax professional or accountant before filing. That way, you can determine if any other requirements have been put into place due to recent changes that impact your ability to benefit from this beneficial tax rule.

Conclusion

Taxpayers can offset capital gains on real estate investments with various strategies. A 1031 exchange or IRC §121 exclusion will reduce the amount owed to Uncle Sam. Renting out the property and taking depreciation deductions and income may also help. Plus, investing in low-income housing may qualify for tax credits from local and state governments.