How to Reduce Capital Gains Tax on Real Estate

Selling your home or investment property? With proper planning, you can significantly reduce — or even eliminate — your capital gains tax liability on real estate. Here’s what you need to know in 2025.

IRS Section 121 Exclusion: The Home Sale Tax Break

Homeowners may be eligible to exclude up to $500,000 in capital gains from the sale of a primary residence, thanks to the IRS Section 121 exclusion.

To qualify:

• You must have owned and lived in the home as your primary residence for at least 2 out of the last 5 years before the sale.
• The 24 months do not need to be consecutive.
• This exclusion can only be used once every two years.
• Exceptions may apply for certain life events: job relocation, health issues, military service, or unforeseen circumstances.

Exclusion Limits:

• $250,000 for single filers
• $500,000 for married couples filing jointly

⚠️ Note: These thresholds are not currently indexed for inflation.

Tax Cuts & Jobs Act: Still Affecting Homeowners in 2025

While this 2017 law is aging, several provisions remain in place:

• State and Local Tax (SALT) deduction: Still capped at $10,000 total for property, income, and sales taxes.
• Mortgage interest deduction: Limited to interest on up to $750,000 in mortgage debt (if the loan was taken after Dec 14, 2017).
• HELOC interest: Deductible only if used to buy, build, or improve the home.

How Real Estate Investment Properties Are Taxed

Capital gains on investment properties are fully taxable:

• Short-term capital gains (property held less than one year): Taxed at ordinary income tax rates (currently 10–37%).
• Long-term capital gains (property held over one year): Taxed at 0%, 15%, or 20%, based on income levels.
• An additional 3.8% Net Investment Income Tax (NIIT) may apply to high earners.

Note: These long-term capital gains brackets are adjusted annually for inflation

You’ll be taxed on the gain, which is calculated as: Sale Price – Adjusted Basis = Gain

Where:

• Adjusted Basis = Purchase price + capital improvements – depreciation claimed.

Depreciation Recapture:

Even if you didn’t claim depreciation, the IRS treats it as if you did. Upon sale, this portion is taxed as ordinary income (up to 25%).

1031 Exchange: Deferring Capital Gains

IRC Section 1031 allows investors to defer capital gains taxes by exchanging one investment property for another of like kind.

Since the 2017 Tax Cuts & Jobs Act, 1031 exchanges are only allowed for real property — personal property no longer qualifies.

1031 exchanges must follow strict rules, including timelines and qualified intermediaries.

Key rules for 1031 Exchanges:

• Must involve real property (no personal property)
• Must use a qualified intermediary
• Must follow strict timelines:
  • 45 days to identify new property
  • 180 days to close the replacement purchase

🔄 1031 is tax-deferred, not tax-free. The deferred gain carries over to the new property and will be recognized when that property is sold (unless another exchange is completed).

Reducing Taxes on Rental Property

Depreciation is still a powerful tool for reducing taxable rental income.Rental properties are depreciated to help offset taxable income.

• Most residential rental properties are depreciated over 27.5 years using the Modified Accelerated Cost Recovery System (MACRS).
• Alternative Depreciation System (ADS) depreciates over 40 years, usually required for foreign property or if elected.Bonus Depreciation Phaseout (as of 2025):

Key updates/reminders:

• Depreciation must be claimed — even if you didn’t take it, the IRS assumes you did and will recapture it upon sale.
• Bonus depreciation (which allowed full expensing in the first year) is phasing down:
  • 80% in 2023
  • 60% in 2024
  • 40% in 2025
  • Fully phased out after 2026 unless extended

This mainly applies to improvements or personal property used in rentals — not the structure itself.

Bottom Line

The IRS Section 121 exclusion remains one of the most powerful tools available to homeowners. Investors, on the other hand, must navigate a more complex tax landscape — but with the right planning (such as 1031 exchanges, depreciation strategies, and timing), it’s still possible to reduce or defer capital gains.

As always, consult your tax advisor to apply these strategies to your personal situation.

Sources

1. IRS Topic No. 701 – Sale of Your Home: https://www.irs.gov/taxtopics/tc701

2. IRS Publication 523 – Selling Your Home: https://www.irs.gov/publications/p523

3. IRS Publication 544 – Sales and Other Dispositions of Assets: https://www.irs.gov/publications/p544

4. IRS Instructions for Form 4797: https://www.irs.gov/forms-pubs/about-form-4797

5. Tax Cuts and Jobs Act – Congress.gov: https://www.congress.gov/bill/115th-congress/house-bill/1

6. IRS Publication 946 – How to Depreciate Property: https://www.irs.gov/publications/p946

7. IRS Like-Kind Exchanges Tips: https://www.irs.gov/newsroom/like-kind-exchanges-real-estate-tax-tips

Disclosures: This material is provided for informational purposes only and should not be used or construed as an offer to sell or a solicitation of an offer to buy any security. Past performance is not indicative of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. Canter Wealth does not render legal, accounting or tax advice; please consult your tax or legal advisors before taking any action that may have tax consequences.