There are few financial transactions more satisfying than selling a piece of property at a large profit – especially if you can defer the tax on that profit. Fortunately, there are several ways to accomplish this, depending upon various factors such as the amount and type of capital gain that is realized. You'll need to know the rules and how they apply to your situation.
If you would like to entirely avoid capital gains tax when selling your property, you can take advantage of IRS Section 1031 guidelines. The IRS allows you to completely defer tax if you reinvest the profit from your first sale into a like-kind property
Deferring Capital Gains Tax on a Sale
If you sell your property at a profit, you can defer the amount of your gain by using the proceeds to buy like-kind property under the IRS' Section 1031 Rules. These rules permit taxpayers to defer any gain on the sale of certain kinds of property if they use the proceeds to purchase similar property. For example, if you sell 10 individual rental properties in the same year, you can use the proceeds to buy all or part of an apartment complex and defer paying tax on the gain because the complex is considered a similar type of property. If you're wondering how to avoid capital gains tax on a second home, such as a vacation home, you can also use the 1031 exchange if you lived in the property at least some of the time. These types of a "like-kind exchange" must be reported on IRS Form 8824.
Reducing Your Tax Burden
If you live in your main home for at least two of the past five years before selling, you can exclude the first $250,000 ($500,000 if married and filing jointly) gain on the sale of your home from taxation. This is one of the largest tax breaks in the entire tax code and applies to all homeowners, regardless of income level. However, this exclusion is only available for your primary residence. Gains from investment and rental properties cannot be excluded, so selling a rental property will not get you this benefit.
Capital Gains Tax Reduction Strategies
To reduce your tax bill further, calculate the net profit you will receive from the sale of your property after expenses and commissions. This will vary depending on the type of property you're selling. If you're selling collectibles or antiques, you will be taxed at a higher rate than for a real estate sale, which may qualify for long-term capital gains treatment. Long-term gains are those made on property or investments that were held for more than one year, and they are taxed at a lower rate than short-term gains, which are taxed at the taxpayer's top marginal tax rate.
Once you've calculated your gain, net any capital losses that you have realized, if possible. You must net the loss in the same year that you realized the gain. If you realized a loss in a prior year, you can deduct only $3,000 of that loss against your current gain if you could not deduct the entire loss in that previous year. For example, if you sell one stock at a $40,000 profit during the year and have another stock on which you lost $20,000, you could sell the loser and report only $20,000 of net gain for the year. But if you sold your stock at a loss the previous year and had no gain against which to declare it, you would be able to declare only $3,000 of the loss that year. Then you could reduce your current $40,000 gain by the remaining $17,000 loss in the current year.
Another way to reduce the tax is to sell your property in a year when you expect to have otherwise unusable tax credits, which reduce your actual tax bill dollar-for-dollar on the bottom line. For example, if you owe $3,300 after all deductions and income have been recorded, a $2,000 tax credit will reduce your tax bill to $1,300. If you're sending kids to college next year, you may be able to claim the corresponding educational tax credits. But if your taxable income is relatively low, some or all of these credits may go unused. The only way to recapture these credits is to increase your income, so selling your property in the year that you receive the credits may allow you to reduce or eliminate the tax assessed on the gain. The same holds true for deductions. If you have a major medical bill you must pay out of pocket and that will reduce your tax bill to zero, consider selling your property that year, so that your otherwise unused deduction can reduce or eliminate your capital gain income.
2018 Capital Gains Tax Rates
Short-term capital gains are taxed as ordinary income, so the 2018 tax brackets for income will apply to short-term gains realized during the 2018 tax year. However, if you held your property for more than one year, the gains are long-term, and the tax is reduced. Long-term capital gains rates for single taxpayers, for example, for a single person for 2018 are 0 percent for the first $38,600 in income; 15 percent of income between $38,600 and $425,800; and 20 percent of income above $425,800. So if you're single and you realize a long-term gain of $100,000 during the 2018 tax year, you'll be taxed nothing on the first $38,600 and 15 percent on the remaining $61,400, for a total tax of $9,210.
2017 Capital Gains Tax Rates
The long-term capital gains tax rates for the 2017 tax year (taxes filed in 2018) are 0 percent for the first $37,950 of income; 15 percent of income between $37,950 and $418,400; and 20 percent for all gains above $418,400. So if you're single and you realized a long-term gain of $100,000 in 2017, you would be taxed nothing on the first $37,950 and 15 percent of the remaining $62,050 for a total of $9,307.50.
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Mark Cussen has more than 17 years of experience in the financial industry. He received his B.S. in English from the University of Kansas and became a Certified Financial Planner in 2001. He has published financial educational articles on such websites as Investopedia and Money Crashers. He also provides financial education and counseling for members of the U.S. military and their families.