If you are a real estate investor you have probably heard about capital gains tax.
There are certain things you should know so you do not have to pay more than you should and make smart decisions for your business.
But first, let’s understand: what exactly is a capital gain?
What is a capital gain?
A capital gain refers to the profits you will see from selling a capital asset. The most common examples are stocks, bonds, and the main reason you are here: real estate.
Capital gain is basically the difference between a higher selling price and a lower purchase price, as you can see here in this easy formula:
Capital Gain = Selling Price – Purchase Price
So, capital gains are a good thing because this means that you made a profit on your assets. But as you might think, your capital gains are going to be taxed just like any other income you and your business earned during the year.
That is why it is important for you as a real estate investor to understand and manage as part of your tax planning and accounting processes.
In this article I will show you 7 important things every real estate investor needs to understand about capital gain.
1. Understand the difference between capital gain and business income
You will be charged every time you sell a real estate property unless you can prove that real estate investing is something you do for a living.
If you can prove that, any profit you made from selling real estate is going to be taxed as business income, not capital gains.
But, how do you know the difference? Well, ask yourself these two questions for each property you are planning to sell:
- Is the transaction you made (selling a property) similar to the normal course of your business? If it is, then it is considered business income.
- How often have you had transactions of this type? If you do this type of transaction frequently or if it follows a pattern, it will be considered business income.
2. Think of tax-loss harvesting
This is a really good way to turn a bad situation into a good one. You can do this if you have investments that are not working so well so you can offset the capital gains from one property against the losses of another.
If you want to try this, focus on short-term losses because there you will see more benefits. You will use the loss to offset short-term gains and these gains have a higher tax rate.
As a warning, you need to be aware of the wash-sale rule because it disallows the decrease in taxes if you buy the same or similar security within 30 days or after the date of your sale.
3. Consider the time for selling
You need to understand the difference between a short-term gain and a long-term gain. If you owned the asset for longer than a year, it is considered a long-term capital gain or loss. If you owned it for one year or less, the gain or loss is short-term.
So, if you hold the property for less than one year before selling it with a profit, you will have to pay a higher tax rate on your profits.
This is something to think about every time you are going to invest in a property.
4. Keep in mind the 1031 exchange
This tax code is the favorite of many people, because it allows you to reinvest the profit from the sale of one investment property into the purchase of another one without paying for your capital gains when you sell the first property.
It is just like moving puzzles but in this case, you are moving money from one investment to another.
You need to remember that this reinvestment process needs to happen within 180 days and this new investment needs to be similar or the same kind to the property you owned previously.
This means that you need to think about the 1031 exchange before completing the actual sale.
5. The importance of asset placement
Another strategy that is frequently used to save money on capital gains taxes is called asset placement.
As a real estate investor, it is important that you know about this strategy and make sure you really understand it before you start implementing it.
Be aware of the requirements and ways to use assets placement. This works by moving a certain type of investment to a specific type of account that has some tax benefits.
So, make sure to check it out and if it works for you it can help you save tons of money.
6. Check for tax-deferred retirement plans
You are probably aware that when you invest money through a retirement plan, it can grow without having to worry about instant taxes.
And you can also make investments and sell properties with your retirement account, without having to pay taxes for your capital gain.
This is another good option you need to take into consideration when investing in your properties.
7. Remember that personal sales are not deductible
In most cases, you do not need to worry about capital gain taxes if you are planning to sell the place where you lived.
You just need to meet a few basic criteria to prove that the house you are selling was your main residence for at least two of the five years prior to the sale.
This can save you money that you are probably going to use when you buy your next home.
So, can you get rid of capital gain tax?
Well, there are ways to save some money but as all taxes, you need to be aware of how to do it to prevent any legal and financial problem.
You cannot get rid of the tax but there are ways to strategically and legally move your money in a smart way.
And by the way, if you need help understanding how you can reduce the amount of capital gain taxes and organizing your accounting situation, we are here to help you.
At Terra Business Solutions we can give you the expert advice you need to make sure that you use your money in the smartest and most efficient way. When we talk about capital gain taxes you obviously want to make smart decisions.
If you are interested in this, feel free to check our website and without any commitment, you can also schedule a call to see if your business and our strategies are a good match.
Click here to schedule a call with us and understand how as a real estate investor you can change your business in the best way possible:
Hope this was helpful for you and it is great to know that now you have a better idea of how you can use the capital gain tax to your favor! Talk to you soon.