Looking to sell a property? The profit gained from your sale may be considered capital gains, which means you will need to understand what capital gains are and know what to expect when it comes to capital gains taxes. Learn about these profits, capital gains taxes, and how they might impact your business as a housing provider, as well as the benefits and potential tax deferments if you choose to reinvest.
Buying and selling property is a common occurrence in the real estate industry, as investors hope to invest their money in increasingly profitable properties. With these sales of property comes profit, and with profit, capital gains and the capital gains taxes that come with earning money.
“Capital gains” is a common term heard within the industry, but not everyone knows what it means. As a real estate investor, landlord, or other real estate owner, you buy and sell property frequently, and the money earned and spent on those investments factor into your capital gains and losses. These gains and losses, and the taxes that come with purchasing or selling property, are important aspects of accounting as a property owner.
Learn about capital gains, capital gains taxes, and the ways you can defer capital gains taxes if you reinvest your profits into another investment.
What are Capital Gains?
Capital gains are the increase in value of one of your assets compared to how much you paid for it initially. You have capital gains when you sell an asset for more money than you paid for it, specifically, real estate in the case of landlords and property investors. There are many assets that can be considered capital assets, including stocks and household furnishings, but this article focuses primarily on capital gains regarding real estate.
As an example, if you were to purchase a property and own it for several years, the increase in value would create your capital gains. If you were to then sell that property, the profit you made selling it would be capital gains, which you would then need to pay the capital gains tax on. There are also short-term and long-term gains, which the IRS differentiates depending on whether you owned the asset for more or less than a year. There are some exceptions to this rule, but most assets fall under it.
Capital Gains Tax
When you sell a long-term asset and earn money in that sale, you may need to pay capital gains tax. The amount of gains taxed depends on the household income and your tax filing status. Typically, these taxes are under 20% of your gains, but some circumstances can cause the cost to be higher. The taxes on selling property, however, are kept below 20%. If your income is below a certain amount, you may not need to pay taxes on the sale at all.
When you sell a short-term asset, your capital gains are taxed the same way as regular income. This means that the amount taxed may be significantly higher depending on your income, and it would not have the possibility of being untaxed.
Learn more: Five Tax Season Tips With Rentec Direct
How You Can Defer Capital Gains Taxes
While you cannot outright avoid capital gains tax, you can defer it under certain circumstances with a 1031 exchange. Investors can sell property without paying capital gains taxes if the equity is used to make a similar purchase, by investing it in another property. Not every property qualifies, but the majority can be considered “like-kind” purchases. While this does not allow you to avoid capital gains taxes, it does defer them, and this allows you to invest in more expensive properties as an investor.
Learn more: Tax Deferred 1031 Exchange Basics for Investors
Final Thoughts
Capital gains are a concept that often sounds more intimidating than they truly are, but they can be easily managed with careful, thorough accounting and awareness of the law. If you understand capital gains, the related taxes, and how to account for your profits and losses, you can use them to reinvest and grow your business.
