There are two certainties in life: death, and taxes. We all need to pay taxes some how or another, but the amount of tax paid can be adjusted with some planning. This knowledge is especially handy when selling property, which can emit a large taxable capital gain. Realized capital gains can be reduced so that you can reduce your tax payable. When I use the word realized, I mean that the property has been sold, hence the difference between the selling price and original cost is “realized”. An “unrealized” gain or loss is one in which the property is still being held.
Here are several ways in which you can reduce your capital gains the next time you want to sell property:
7. Use Realized Losses to Offset Taxes
When reporting your taxable gains from property, you can use capital losses that you incurred in the year to reduce your gain for up to $3,000. The $3,000 of losses can also be applied to other incomes, such as business income. Excess losses can be carried forward indefinitely to future years when you have capital gains.
If you don’t have capital losses, check your stock portfolio. See if there are any stocks that are currently at losses (the price you paid minus the current share price times the number of shares you own). If there are, determine whether or not you want to sell them – they may be hopeless causes anyway. If there aren’t any, just sell the stock and then repurchase it a few weeks later. That way, you can realize a loss to offset your capital gains.
6. Gift Property to a Low-income Family Member
Perhaps you’re making a high amount of income if you’re the breadwinner of the family. You will then be taxed at a high income tax bracket. Give the property you own to a family member with a lower income, such as your spouse, or child. The property will retain the same cost base that you did. However, when he or she goes to sell the property, their capital gain will be taxed at their tax rate rather than yours. This results in the same amount of gain as if you were to hold the property, but taxed at a lower rate since a lower income individual owned and sold the property.
5. Primary Residence Exclusion
A married couple is eligible for up to $500,000 of capital gains exclusion from the sale of their primary residence, while an individual is eligible for up to $250,000. Some people decide to sell their home and relocate in order to gain access to the capital without incurring tax.
This exclusion can also be used to your advantage if you are a married couple with an adult son or daughter living at home. You can gift your daughter one-third of the property, so that you and your spouse own two-thirds and your daughter owns the remaining third. When it comes time to sell the property, your daughter can sell her share of the property for $250,000 without incurring tax. You and your spouse could sell your portion for $500,000 without incurring tax as well. Originally, you and your spouse could only shelter $500,000 of the gain, but if you gift part of the property to someone, a greater portion of capital gains can be sheltered.
4. House Flipping
Some people, home renovators in particular, purchase below market-value homes to use as primary residences. They then fix the house and flip it. As a result, they sell at a profit but avoid taxes due to the primary residence exclusion. The leasehold improvements that go into fixing the house are calculated into the cost of the house.
3. 1031 Exchange
Named after the relevant tax section, IRC Section 1031 provides an exception when selling a business or investment property and allows for postponement of the taxable gain if reinvested in a like-kind property. The proceeds must be reinvested into a similar investment within 180 days.
Note that exchange is a form of tax deferral, rather than being tax free. Hence, you must pay capital gains tax on the newly acquired investment upon sale. Still, deferring tax is better than paying it right away due to the opportunity costs involved in immediate tax liabilities.
2. Hold and Lease
There are many people who enjoy being landowners. They buy a piece of property, and then set out to lease it to renters. Once in awhile, they put in some leasehold improvements, such as fixing the air conditioning, or replacing the countertop, which get put into the original cost of the property. As the property gains value, they can charge higher rent to earn a tidy profit. Dealing with unruly tenants who don’t pay up can be a hassle, however.
When you begin renting out property, you do lose access to the primary residence exclusion. Also, your rental income will be taxed at a less favourable rate than capital gains.
1. Move Somewhere With More Favorable Taxation Rates
So you really, really hate capital gains and are willing to move somewhere with more favorable gains. Different areas have different laws and rates on taxation. For example, California has the highest capital gains rate in the US and the second highest in the world at 37.1%. However, Alaska, Florida, South Dakota, Tennessee, Texas, Washington and Wyoming are on the opposite end of the spectrum, since these states do not add anything on top of the federal tax rate. At the highest income level, you’ll only be paying 23.8%.
Some lotteries give away homes as a prize. If you’re lucky enough to live somewhere in Canada or the UK, for example, lottery winnings are not taxable. So, if you have won a piece of property from a registered lottery, you can sell the property and not incur any taxes from it at all. Unfortunately, lottery winnings are taxable in the US, which means you’ll still have to pay capital gains once you sell the property (unless you craftily devised a plan involving one of the above methods).
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