How to Reduce Capital Gains Tax on Your Primary Residence
Qualified homeowners can exclude from their taxable income up to $500,000 in capital gains using IRS Section 121 Exclusion.
Qualifying for the Exclusion:
Your home must be used as a primary residence for at least 24 months out of the last 60 months before you sell it (two out of the last five years).
The 24 months does not have to be consecutive. There are certain exceptions to the 24-month requirement when a change of employment, health, military service or other “unforeseen circumstances” have occurred.
Generally, you can only claim one exclusion every two years.
If you meet the qualifications, you can exclude up to $250,000 in capital gains per homeowner and up to $500,000 for a married couple filing a joint income tax return.
Tax Cuts & Jobs Act of 2017 – How it Affects Real Estate
State and local property tax deductions are limited to a combined $10,000 for income, sales, and property taxes.
Mortgage interest deduction is capped at $750,0000 of indebtedness for new loans, reduced from $1,000,000. Old loans taken before 12/14/17 are grandfathered and are not subject to the new $750,000 cap.
Blanket deduction for Home Equity Line of Credit (HELOC) is eliminated.
How Real Estate Investment Properties are Taxed
When you sell a real estate investment property, you are taxed at the capital gains rate according to your holding period.
- Short-term Capital Gains: Property sold with less than 1-year holding period. Taxed at marginal income tax rates of 10-37%.
- Long-term Capital Gains: Property sold with greater than 1-year holding period. Taxed at long-term capital gains rate of 0-23.8%. (Source: IRS.gov, 2018)
The gain is the difference between sale proceeds and the adjusted basis on the property. Adjusted basis is calculated from when you acquired the property, adding in any capital improvements and deducting the depreciation claimed on the property.
Depreciation claimed is subject to “recapture rules,” which means you report some of the gains when you sell the property at ordinary income tax rates and some of the gains at capital gain tax rates. You are able to deduct selling expenses, including commissions paid on the sale.
IRC Section 1031 allows you to postpone paying tax on the gain if you reinvest the proceeds in a similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free. Specific rules apply to how the transaction is executed, consult your advisor for your personal situation.
Reducing Taxes on Rental Property
Depreciation is an income tax deduction that enables taxpayers to recover the cost of certain property, including rental property. Rather than taking one large deduction in the year you purchase (or improve) the property, depreciation distributes the deduction across the useful life of the property.
- Using the Modified Accelerated Cost Recovery System, or MACRS, the residential rental property can be depreciated over 27 1/2 years.
- Or over 40 years using the alternative depreciation system.
- Claiming depreciation isn’t optional. Even if you didn’t claim depreciation, it is subject to recapture when you sell the property.
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.