How To Prevent Capital Gains Tax When Selling Your Rental Property
Owning rental properties can come with a lot of perks. Every month you’re receiving a check for doing little to no work (if you have a property manager). This extra, reliable stream of income can really add a cushion to your finances.
However, selling this property can cost you– you’ll have to pay taxes on the capital gains (aka profit). For 2018, the long-term capital gains tax rate is 15% if you are married filing jointly with taxable income between $77,201 and $479,000.
And if your income is $479,001 or more, the capital gains rate shoots up to 20%.
Selling rental property could result in paying out a significant amount of money in taxes, all depending on the profit you gain from the sale.
So, for example: a married couple, filing jointly, with taxable income of $480,000 and capital gains of $100,000 would be taxed on those rental-property gains at about $20,000.
Now, if I’ve scared you then know that there is a way to reduce capital gains tax when you sell a rental property. All hope is not lost!
Offset Gains with Losses
Some people refer to this as tax-loss harvesting. This gives you the ability to subtract any capital losses from the capital gains received from the rental property sale.
This strategy is popular at the end the year to decrease the amount they owe from stock gains, but it translates well to rental real estate property, too!
Say you made $100,000 off the sale of a rental apartment, but took a bath in the stock market and lost $15,000. You can offset part of the $100,000 in capital gains.
Turn Your Rental Property into Your Primary Residence
This one is a little more self explanatory. Convert your rental property to your primary for better tax treatment when you sell. This gives you the ability to exclude as much as $500,000 in capital gains from taxes!
IRS Section 121 allows the exclusion of up to $250,000 of profits from the sale of a primary residence if you are single. And if you’re married and filing jointly, then you can exclude $500,000 (marriage has a ton of benefits in the real estate realm).
To avoid capital gains tax with this option, you must have owned the home for 5 years and resided in it for at least 2 of those years.
The amount of your deduction depends on how long the property was used for rental versus as a primary residence.
So, for example, let’s assume you bought a house 5 years ago for $100,000 and rented it out for the first three years. Two years ago, you moved in and then sold the house recently for $220,000. You will have realized $120,000 in capital gains but can only deduct two-fifths (40%) of that amount since you only lived in the home 2 of those 5 years. The remaining $72,000 in capital gains will be subject to capital gains taxes.
Owning a rental property provides you with many perks. But sometimes, consulting a professional or simply doing your own research can open up a whole new world of options when it comes to your rental property.
If you have more questions about how your rental property can be of better assistance to you, feel free to give us a call!