Capital Good points Tax: An Inevitable Actuality
I firmly believe that real estate investments are one of the most effective strategies for building wealth. Not only that, but prosperity through too passive Income. And as you might have guessed, I'm a huge fan of making income as passive as possible.
Unfortunately, there is one major drawback that occurs every April. Yes, it's taxes.
Of course, taxes aren't just for real estate investments, but they can certainly be more intimidating. This is especially true for the dreaded capital gains tax.
For today's post, we're going to look at what capital gains tax is, when it applies, and how to manage it. Let's get to that in a moment.
What is capital gains tax?
Put simply, if you sell a property for more than you paid for it, you have to pay taxes on the profit you made. But find out how much You have to pay – that's the hard part.
First, it should be noted that there are two main categories of capital gains tax: short-term and long-term.
Any investment held for a year or less is taken into account short termand it is taxed at the same rate as your regular income.
However, if you hold it for more than a year it will be taken into account long term. Things change pretty much here. The following table compares the percentage that the IRS will take based on your capital contribution status depending on your tax return status:
These are the basics of capital gains taxes that get to the point. The question now is: are there situations in which you do not have to pay these taxes?
Exclusions from capital gains tax
While there are likely to be some exclusions regarding loopholes in paying taxes on capital gains, we'll only cover the most common and effective ones.
First, there is House exclusion advantage. In general, you can avoid paying capital gains taxes when selling a property if you:
- Lived in the apartment for 2 of the last 5 years
- Make less than $ 250,000 (or $ 500,000 if you're married and filing together) in profits from sales
That's pretty much it. You don't even have to live at home for two years in a row – as long as you've lived in the apartment for a total of two years in the last five years, you will qualify.
The other great way to deal with capital gains is to use a 1031 exchange. I talk about it in much more detail Here, but I should point out that this is not an exclusion per se. Instead, taxes can be deferred – sometimes indefinitely.
If you sell a property at a profit and then use the capital gains to buy another rental property, capital gains tax is accrued until the next property is sold. That said, if you don't also use the profits from that property to buy the next one, you have the idea.
If, according to the applicable rules, you pass the property on to your children when you die, they can take over the property on a so-called "reinforced basis". You essentially receive the property at the current market value and the accumulated increase in value (and thus the deferred taxes) are deleted.
This can be a very powerful tool for creating generational wealth.
There are a few qualifications that you must meet in order to take advantage of a 1031 exchange. Please see the link above for more information.
In general, a 1031 exchange is great for two reasons: Not only can you avoid paying capital gains taxes now, but if you buy and sell real estate frequently, that tax shift can shift your interest rate from the short term to the long term.
Since there is so much tax law involved (especially real estate) it is of course best to speak to a tax professional before making any decisions based on that knowledge.
The bottom line
Capital gains tax is an inevitable reality for most, especially when the time comes to sell an investment property. However, there are several ways you can defer this amount or eliminate it entirely. But the most important thing you can do is be proactive.
Learning taxes isn't exactly the funnest thing in the world, but the more you know about it, the more you can reduce the income that you have to share with good old Uncle Sam and the closer you can to achieving real financial life Situation come independence.