One of the primary concerns about getting into real estate investing is how you’ll be taxed on the returns produced by the investments. There are many different scenarios that affect the way real estate investment gains are taxed, with some being far better than others.
Being aware of the capital gains tax implications could be the difference between paying zero taxes and paying more than 37%. In this article, we’ll cover the ins and outs of how real estate investment gains are taxed so you can maximize your net returns on your capital.
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What Are Capital Gains?
When you sell real estate for more than you paid for it, the difference is called a capital gain. For taxation purposes, there are two categories of capital gains—short-term capital gains and long-term capital gains. Each category of capital gains is taxed differently.
Short Term Capital Gains
When you buy and hold a piece of real estate for one year or less, the capital gains are classified as short-term. Short-term capital gains are taxed like your regular wage income, with seven different rate brackets that range from 10% to 37% depending on if you’re filing single or married and what your income was for the year.
If you flip a house, any money you earn from the sale will be taxed as short-term gains if you don’t hold the property for at least a year. Holding the property for at least a year will classify the capital gains as long-term, which have substantially lower tax rates.
What Are The Long-Term Capital Gains Tax Rates For 2021?
|FILING STATUS||0% RATE||15% RATE||20% RATE|
|Single||Up to $40,400||$40,401 – $445,850||Over $445,850|
|Married filing jointly||Up to $80,800||$80,801 – $501,600||Over $501,600|
|Married filing separately||Up to $40,400||$40,401 – $250,800||Over $250,800|
|Head of household||Up to $54,100||$54,101 – $473,750||Over $473,750|
High-Income Investors May Have To Pay An Extra 3.8% Tax
If your modified adjusted gross income is over a certain amount, you’ll owe an extra 3.8%, called the Net Investment Income tax, regardless of the gains being short or long-term.
When Does The Net Investment Income Tax Kick In?
- $250,000 if you’re married and filing jointly
- $125,000 if you’re married and filing separately
- $200,000 if you’re a single filer
- $200,000 for heads of households
- $250,000 for qualifying widow(er)s with dependent children
How Real Estate Capital Gains Are Calculated
When you sell real estate, the profits are subject to capital gains taxes, but there are some criteria that reduce what’s considered taxable profit.
To calculate the capital gain, you subtract the “cost basis” of the property from the “net proceeds” from the sale. This means your taxable profit could be smaller than what you first think.
The Cost Basis Method
Cost basis is calculated as the amount you paid for the property, plus:
- Costs related to the purchase, such as closing costs, appraisal fees, and legal fees
- Costs of any major improvements made to the property
Note that qualifying improvements must add value to the property, change its use, or make it last longer. Routine maintenance and cosmetic changes to make the property look better don’t qualify.
The Net Proceeds Method
When you sell your property, the costs associated with the sale, like real estate agent’s commissions, home staging, cleaning, and legal fees, can be subtracted from the proceeds to arrive at the net proceeds.
For example, selling an investment property for $200,000 with $12,000 in agent commissions and $2,000 in other costs, your net proceeds would be $186,000.
To calculate the capital gains on a real estate asset, you’ll subtract the cost basis from the net proceeds.
Reduce Capital Gains Tax Using The Section 1031 exchange
One major tax benefit for committed real estate investors is the Section 1031 exchange, which allows you to defer capital gains taxes when you buy another property with the sales proceeds.
The Section 1031 exchange is a tax code provision that allows you to sell an investment property (called the “relinquished property”) and defer paying taxes when you buy a “like-kind” property. Occasionally this is also called the Starker Exchange or like-kind exchange.
For your property to qualify as like-kind, it must be real estate that you’ve held for productive use in a trade for business or for an investment. Personal residences don’t count, nor do vacation homes.
While the 1031 exchange is incredibly useful, there are strict time limits to qualify.
You’ll only have 45 days to find up to three potential like-kind exchange properties. Then, you have to close on the new property within 180 days of selling the investment property or before your tax returns are due for the year in which you sold the property, whichever comes first.
Failure to meet these deadlines will disqualify the transaction from being classified as a 1031 exchange, and any applicable capital gains taxes will become due.
Keeping Capital Gains Taxes To A Minimum
Capital gains taxes can cost you hundreds of thousands of dollars in lost profits when you sell your investment real estate. Thankfully, understanding the ways capital gains are calculated on investment property deals can help you keep these taxes to a minimum.
That said, taxes for real estate investments can be complicated, with rules changing sometimes. So, it’s always best to find a well-qualified real estate investment tax specialist to ensure you don’t overlook opportunities to save on capital gains taxes.
Are You Ready To Invest In Real Estate?
Real estate investing is one of the most advantageous avenues for minimizing capital gains taxes if you’ve been searching for ways to diversify your portfolio.
When you want a team of real estate experts who will scrutinize every deal with precision and also provide you with detailed reporting regarding your real estate investment performance, Saint Investment Group is here to help you start investing. Call (323) 483-0291 today to learn more.
**** Saint Investment Group is NOT a CPA, or attorney. The above is opinion only, and should not be construed as legal, investment, or accounting advice. We absolutely recommend consulting your tax and legal professionals for questions, and to confirm accuracy of any information.
Frequently Asked Questions:
Capital gains tax is imposed on the profit gained from the sale of assets, such as real estate, stocks, and bonds, that have risen in value. The amount of tax owing is dependent on the increase in value from the initial purchase price to the selling price and the tax rate might vary depending on the jurisdiction and the kind of asset being sold.
Yes, investment property typically incurs capital gains tax. Capital gains tax applies to investment property sales. Capital gains taxes vary by jurisdiction, holding term, and asset type.
The capital gains tax on investment property is calculated as the profit from the sale (selling price minus original purchase price and related expenses) and is subject to capital gains tax, which varies by jurisdiction and other factors such as holding period and tax bracket.
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.