Tax Tips for Selling Real Estate Investments

Deciding to invest in real estate is usually a fantastic idea and easily turns into a successful business fairly soon. Buy-to-rent schemes in most cases work seamlessly and you are able to make profit quickly, not only by collecting monthly payments, but also by deducting a fair amount of costs related to the property from your tax return. When it comes to property investment with the intention to sell, however, things get a little more complicated and if you are not informed well enough, you may end up with much less profit than you expected due to various tax implications.

Capital Gains Tax

The worst enemy of every property investor is the capital gains tax as it often eats up a big chunk of your profit. Capital gains is basically the tax you pay on the extra money you have left after you’ve sold your real estate and have deducted the cost you acquired it for plus the cost of selling. At a glance it sounds pretty much straightforward, but in reality there are more taxation rules that apply. Furthermore, there are different tax brackets, which determine the percentage of tax you would pay on your profit. For example, if you fall into the 25%, 33% and 35% tax brackets (as most people do), you would pay 15% to the IRS. If the tax bracket is higher (39.5%), you would have to share 20% of your profit with Uncle Sam.

Depreciation

If depreciation is something good when it comes to deducting from your tax return as a landlord, it certainly plays a more negative role when you have to pay capital gains on your sale profit. To illustrate the impact of depreciation let’s accept you bought a property for $200,000 and two years later you sold it for $300,000 without using the help of any agents or paid-for property sites. This is $100,000 in profit, which means you would need to pay 15% ($15,000) in capital gains. However, by law you are required to add depreciation rates to the total profit figure. If the depreciation rate each year was 10% that means that for the two years you’ve owned the property its worth decreased by 20% of the price you bought for, so it became $160,000. This means you need to add the $40,000 difference or depreciation to the $100,000 you made on top of the cost of acquiring the real estate. Finally, you end up with $140,000 as a total sale profit on which you now owe capital gains to the IRS. So instead of being left with $85,000 as most people assume, you will have $79,000 because you are deducting 15% of $140,000 instead of $100,000, but the depreciation is not actual cash.

State Taxes

If you thought it’s bad enough, it’s about to get a little bit worse. Different states have different taxation rates on real estate sales profit, which are usually not so dramatic, but if you made a decent amount of money from a successful property investment, the figure you would have to pay to the state in the form of tax will still be quite significant. That, of course, on top of any capital gain taxes.

Ways to Help Keep Most of Your Profit

While it is impossible to completely escape sharing your profit with the IRS and other official institutions, there are some ways in which you can keep a bigger part of the money only to yourself. You can’t really do anything about the state taxes because they are set to a certain amount and the local regulatory bodies will chase you to collect their piece of the pie. However in relation to the elephant in the room - the capital gains you could adopt particular strategies to minimize the amount of money you owe.

Incorporation

If you’ve invested in real estate with the intention to rent or sell it, then why not turn your small business into an incorporated company. The benefits of doing that are clear - the incorporation acts as a shield over your income and different tax rules apply to companies as opposed to individuals. In addition, if at any point while renting out the property, your tenants decide to sue you for something, your assets will be protected. This applies to your personal finances and the real estate.

The 1031 Exchange

This is a great move for someone who is serious about long-term real estate investment. Most common scenario is a landlord selling their existing property and using the money to buy another similar to the one they sold. In such instances the law allows to skip paying capital gains on any profit made, as long as it is used to acquire the new like-kind property. It is also possible to swap a current property for more than one of that or similar kind. In such transactions, however, there might be too many setbacks and unclear rules so if you opt for a strategy like this, you better find yourself an experienced CPA to navigate the transactions and files.

The 1031 Exchange tax relief could also work for growing families who want to move to a different area or to a bigger house but want to keep some of the money they made of selling their old property instead of paying it to the IRS. Although this kind of transactions should be pretty uncomplicated, it is advisable you book a consultation with a qualified CPA before you take any actions.

Making the Property your Primary Residency

If you have lived in a property for 2 out of 5 years of you owning it, you can sell it with paying minimal capital gains taxes. For example for single people the deductions draw up to $250,000 and for married couples it goes up to $500,000. You don’t need to be living in the property at the moment of sale, but the less time it has been rented out, the bigger the deduction.

Leave your comment below or send us an email if you need any further information.

Fulton Abraham Sanchez, the founder of FAS CPA & Consultants of Miami, FL, is a Certified Public Accountant specialized in Offshore Banking Consulting. You can email him to [email protected].

Contact us [email protected] or call us 786-462-7899 to schedule a confidential consultation.