What is Capital Gains Tax in Real Estate Investing?
Capital gains taxes can be a complicated subject, but important to understand. The more you know about them, the better equipped you will be to make smart decisions when investing in real estate. In this blog, we will review the basics of capital gains in real estate investing.
In real estate investing, capital gains tax is a tax on the profit you make when you sell your home or investment property. If you have capital gains from selling a principal residence or business property, those are exempt from capital gains taxes. Capital gains tax applies only when there's an increase in the value of your asset after you buy it and then sell it for more than what you paid for it—or whenever someone else buys your house or business building for more than what he or she pays (for example). In this case, the difference between what they paid and what they got from you becomes taxable income.
What is capital gains tax?
Capital gains tax is a tax on the profit you make when you sell an asset. It applies to real estate investments, stocks, bonds, and other assets.
There are two main types of capital gains taxes: short-term and long-term. This is determined by how long you've owned the property in question. In general, if you have held an asset for more than one year before selling it (and not longer than one year after buying), then this would be considered a long-term capital gain and taxed at lower rates than short-term capital gains—but still at higher rates than regular income.
Capital Gains Tax in Real Estate Investing
When you sell a property that you’ve owned for more than a year, the profit will be taxed as a capital gain. Although this can seem like an unfair burden, paying the government its share of the profits gained through real estate investing is necessary. Real estate investors must pay capital gains tax on all non-owner occupied properties sold before two years have elapsed and all owner-occupied homes after one year of ownership. The rates vary depending on your total income level and whether or not you qualify for certain deductions (such as depreciation).
What affects capital gains taxes?
The capital gains tax formula is calculated by subtracting your original purchase price from your sale price and then dividing that amount by two. If this amount is higher than your annual income, you'll have to pay taxes on it.
Paying capital gains tax on real estate investing
If you’re a real estate investor, you need to be in the top income tax bracket to pay capital gains tax.
Capital gains tax is calculated on the profit you make from selling an investment property. For example, if you purchased a house for $100,000 and sold it for $175,000 then your capital gain is $75k. In this example, your marginal tax rate would be 25% (on ordinary income), so you would only have to pay around $18k in taxes on that profit. If however, you were taxed at 45% because your income was higher than average then even though the same transaction took place; it would cost an extra $22k! Your marginal tax rate only applies to amounts earned above thresholds set by the IRS each year based on filing status (married filing jointly or single).
How long do you need to wait to avoid capital gains tax on a real estate investment property?
The length of time you need to wait to avoid capital gain taxes on real estate investment property depends on how long you owned the property. If you owned the property for less than a year, you will pay short-term capital gains tax.
If you owned the property for one or more years, then your profit is long-term and subject to lower rates.
Using capital loss to offset your capital gain
You may be able to use your capital loss to offset your capital gains. A capital loss is a difference between the sale price and the original purchase price of an asset. For example, if you buy a property for $100,000 and sell it for $50,000, you have a $50,000 capital loss.
You can deduct up to $3,000 in total capital losses from your net capital gains (the amount of money invested) if you have more than three years' worth of losses at any given time after deducting them from your net gains for that year then any additional losses will be carried forward until they can be used in future years.
Capital gains taxes can be a confusing and complicated subject, but they are essential to understand. The more you know about them, the better equipped you will be to make smart decisions when investing in real estate.