Selling investment property in itself is a very profitable activity when it comes to making several dollars; however, on the flip side, it is subject to taxes. The Internal Revenue Service, or IRS, taxes the profit earned from selling real estate, thus bringing down the actual total gain. However, several of the hot suggestions here can be very helpful in minimizing tax liability when you sell investment property. Here are some of the important ones:
Understanding capital gains tax
Improperly taken sale will result in capital gains tax liability on the profit realized from selling that investment property. The tax on capital gains is on the difference between the sale price and the original price of the property minus any selling expenses. Besides, if you own the property for more than a year, then your gain will be classified as long-term capital gain, which is generally taxed at a lower rate than short-term gains.
Understanding whether your gain is short-term or long-term makes the difference in tax treatment because long-term capital gains are taxed at a much more favorable rate than short-term gains. Long-term capital gains tax rates apply mostly between 0% and 20%, depending on the income level.
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Make considerations
Reduction of taxable gain might sometimes be determined by allowing deductions from certain expenses about the property. For instance, property tax, interest on mortgages, insurance, and maintenance costs can sometimes be deducted from rental income during the period of ownership.
A deduction is also that of selling costs, for example, agents’ commission, closing costs, and repairs essential to making a property sellable. Collectively, these reduce the taxable gain realized in the sale severely.
Opt for a 1031 exchange
The greatest of tools for tax minimization on the sale of an investment property is the 1031 exchange. The 1031 exchange allows one to defer the payment of capital gains tax after reinvesting in another similar property. To qualify for the new property, certain rules should be observed concerning the transaction. Proper execution allows one to never pay tax on such transactions; however, when the new property is sold, it becomes taxable income.
The 1031 exchange especially favors the real estate investor seeking to grow his portfolio while delaying tax disadvantages. However, a qualified intermediary must be used along with a tax advisor, making sure every requirement is met.
Depreciation recapture
The next consideration is depreciation at the time of sale of the investment property. You probably have been recording depreciation on your property as part of your taxable income. When you sell the property, however, you are now going to “recapture” that depreciation and will have to pay tax on it. The depreciation recapture tax is generally at a 25-percent rate.
To minimize this tax, you might consider such strategies as timing the sale of your property to coincide with a period when you expect lower taxable income or shielding depreciation recapture against other tax deductions or credits
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Offsetting profits with losses and other stuff
If you sold off some other investment at a loss, you can probably use it to offset the gains on your real estate sale. This strategy is known as tax-loss harvesting. It helps override taxable income, therefore minimizing your tax liabilities.
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