There are some caveats though. First, you can only claim this exclu- sion once every two years. Second, if you claimed depreciation on the rental home on a previous tax return, you’ll need to pay a depreciation recapture tax of 25% before claiming it as a primary residence. So, if you deducted $8,000 in depreciation, you would owe $2,000 in taxes, which is still much less than you could end up owing in capital gains taxes. Of course, the major downside to this strategy is that you delay the sale of your home—and you just want to live in the property for a couple of years to avoid capital gains taxes. It’s lucrative, but not a strategy that will work for everyone. Capital gains tax is sometimes avoidable, but not always. The three strategies presented here can help you offset, avoid, or minimize capital gains tax requirements, but they’re not ideal for all real estate investors. In cases where you’ll need to pay capital gains taxes when selling your rental property, proper tax planning can help you get ahead. Talking to a certified professional accountant or real estate lawyer can help you better understand your tax liability as a real estate investor. A tax professional can also help you understand the tax deductions and exclusions available to you and help you can find the best method to lower your tax bill. •
2. REPORT YOUR CAPITAL LOSSES TO OFFSET YOUR CAPITAL GAINS If you don’t want to buy a new property right away, you can still minimize the capital gains taxes from the sale of your rental prop- erty by reporting all your capital losses as well. Also known as tax loss harvesting, you can opt to sell properties or other assets at a loss to help offset any gains you make from selling a rental home. For example, if you have stocks that have depleted in value—and you don’t expect to recuperate your money—selling them at a loss can help lower your tax burden on your property sale. You can also carry over capital losses by one tax year. So, if you have major losses this year and anticipate a large profit next year, carrying over your losses can help minimize the amount you’ll pay in taxes. And, if your losses are greater than your gains, you can deduct $1,500 from your taxable income ($3,000 if you’re married, filing jointly). 3. MAKE ONE OF YOUR RENTAL PROPERTIES YOUR PRIMARY RESIDENCE There are capital gains exclusions for primary residences that don’t exist for rental properties. When you sell your primary residence, you can exclude the first $250,000 in profit from capital gains tax (and up to $500,000 if you’re married, filing jointly). So, if you have a rental property that has increased substantially in value, you could potentially avoid capital gains taxes altogether by moving into it and making it your primary residence. To receive the capital gains exclusion, you must live in the property for two years.
to the building you sold would not be eligible for a 1031 exchange. There are a few other require- ments to qualify for a 1031 exchange. First, you must identify the property you wish to buy within 45 days of your rental property sale. That means you should already have a few properties in mind, so you can move quickly. Since you have to close within 180 days, it’s best to identify a property that you can buy quickly. And, until you close on the new property, you’re not allowed to touch the profits from the first sale. If you do, you’re no longer able to do a 1031 exchange. It’s recommended you leave your profits with an intermediary or third party, like an escrow company, to avoid complications. Keep in mind, this strategy doesn’t completely wipe away capital gains taxes from your plate, but it pushes them down the line until you no longer want to keep buying new “like-kind” properties.
Luke Babich is the co-founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers, and investors make
smarter financial decisions. Babich is a licensed real estate agent in the state of Missouri. His research and insights have been featured on BiggerPockets, Inman, the LA Times, and other online and media outlets. Babich earned a bachelor’s degree in political science, with honors, from Stanford University.
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