Capital Gains Tax on Real Estate – And 14 Ways to Avoid It (2024)

When you sell a property for a profit, you owe capital gains taxes on it. Maybe. Sometimes. If you don’t know how to avoid real estate capital taxes.

Because real estate investments come with a slew of tax advantages. While you own the property as a rental, you can take nearly two dozen landlord tax deductions. And when it comes time to sell, you can reduce or avoid capital gains taxes on real estate through another half dozen options.

Start thinking about your real estate exit strategies now, long before you’re actually ready to sell. By positioning yourself early, you can dodge the bullet of capital gains taxes on investment properties altogether.

Key Takeaways:

    • The IRS taxes your profits on real estate and other investments as capital gains.
    • The tax rate on capital gains is lower than regular income — if you owned the investment for at least a year.
    • Real estate investors have many options to reduce, defer, or avoid capital gains taxes.

In This Article:

What Are Capital Gains Taxes on Real Estate?

The IRS requires you to pay taxes on your profits when you buy low and sell high. Capital gains taxes apply whether you earn a profit buying and selling stocks, collectibles, or anything else of value — including real estate.

Uncle Sam calculates your capital gain by subtracting your cost basis (the amount you paid) from the sale price, minus any expenses such as Realtor fees. As with all income and profits, you must report these gains to the IRS.

You can sometimes increase your cost basis to lower your capital gains. For example, you can add some purchase closing costs to your cost basis. Likewise, you can add the cost of property improvements to lift your cost basis and reduce your taxable gain.

Nt all capital gains are treated equally. Capital gain taxes depend on how long you owned the asset, whether you lived in the property as your primary residence, and any adjustments you can make to your cost basis. Homeowners get a special exemption from capital gains taxes, up to $250,000 per spouse (more on that shortly).

Lower capital gains taxes apply to assets you owned for at least a year, referred to as long-term capital gains.

How Much Is Capital Gains Tax in Real Estate?

If you own an asset for less than a year, you’ll owe short-term capital gains tax on it. The IRS taxes these short-term profits at the regular income tax bracket rates. For example, if you pay taxes at the 24% tax bracket, you’ll owe Uncle Sam 24% of your short-term capital gains from that year.

If you hold an asset longer than a year, the IRS taxes your gains at a lower tax rate. Expect to pay 0-20% (exact tax tables below).

Another crucial difference between how capital gains are taxed versus ordinary income: you don’t pay different tax rates for different income segments. If your total taxable income is above the threshold for paying 15% capital gains tax, all of your capital gains are taxed at 15%.

For example, say you earned $150,000 last year, of which $50,000 were long-term capital gains. You pay 15% of the total capital gains, rather than paying 0% on one portion and 15% on another (the way that ordinary income tax brackets work. You’d pay a total capital gains tax bill of $7,500 for the year.

Short-Term vs. Long-Term Capital Gains

Before diving into individual strategies to avoid real estate capital gains taxes, you first need a baseline understanding of short-term versus long-term capital gains.

If you own an asset — any asset — for less than a year and then sell it for a profit, the IRS classifies that profit as a short-term capital gain, taxed at your regular income tax rates. For example, say you flip a house and earn a $50,000 profit on top of your $85,000 salary. As a single person, you would pay taxes on that extra $50,000 in income at the 24% federal tax rate.

Regular income tax rates, and therefore short-term capital gains tax rates, read as follows in 2023:

Tax RateSingleMarried Filing JointlyHead of Household
10%$0 – $11,000$0 – $22,000$0 – $15,700
12%$11,001 – $44,725
$22,001 – $89,450
$15,701 – $59,850
22%$44,726 – $95,375
$89,451 – $190,750
$59,851 – $95,350
24%$95,376 – $182,100
$190,751 – $364,200
$95,351 – $182,100
32%$182,101 – $231,250
$364,201 – $462,500
$182,101 – $231,250
35%$231,251 – $578,125
$462,501 – $693,750
$231,251 – $578,100
37%$578,126 and up
$693,751 and up$578,101 and up

But when you own an asset for more than a year and sell it for a profit, the IRS classifies that income as a long-term capital gain. Instead of taxing it at your regular income tax rate, they tax it at the lower long-term capital gains tax rate (15% for most Americans).

Here are the long-term capital gains tax brackets for tax year 2022:

Capital Gains Tax RateSingleMarried Filing JointlyHead of Household
0%$0 – $41,675$0 – $83,350$0 – $55,800
15%$41,676– $459,750$83,351 – $517,200$55,801 – $488,500
20%$459,751 and up$517,201 and up$488,501 and up
Additional Net Investment Income Tax
3.8%MAGI above $200,000MAGI above $250,000MAGI above $200,000

And the long-term capital gains brackets for 2023:

Capital Gains Tax RateSingleMarried Filing JointlyHead of Household
0%$0 – $44,625$0 – $89,250$0 – $59,750
15%$44,626 – $492,300$89,251 – $553,850$59,751 – $523,050
20%$492,301 and up$553,851 and up$523,051 and up
Additional Net Investment Income Tax (NIIT)
3.8%MAGI above $200,000MAGI above $250,000MAGI above $200,000

The easiest way to lower your capital gains taxes is simply to own the asset, whether real estate or stocks, for at least a year.

Capital Gains Tax on Home Sales vs. Rental Properties

The short version: homeowners get an exemption on capital gains tax (under some circumstances). Landlords don’t.

Single homeowners can avoid capital gains tax on the first $250,000 of profits; married homeowners can dodge capital gains tax on up to $500,000. They must have lived in the property for at least two of the last five years however. That means second homes or vacation homes don’t qualify (more on the Section 121 exclusion below). House hackers who live in a property with up to four units, or a single-family property with an accessory dwelling unit, do qualify for the exclusion.

Real estate investors don’t get this homeowner exclusion for capital gains tax. So how can they avoid capital taxes on real estate?

When Do You Pay Capital Gains Tax on a Home Sale?

You typically pay capital gains taxes on sold properties along with the rest of your tax return on April 15.

However the IRS may hit you with a penalty if you owe a large capital gains tax bill and fail to make estimated tax payments throughout the same tax year. Specifically, the IRS says “Generally, you must make estimated tax payments for the current tax year if both of the following apply:

    • You expect to owe at least $1,000 in tax for the current tax year after subtracting your withholding and refundable credits, and
    • You expect your withholding and refundable credits to be less than the smaller of:
      • 90% of the tax to be shown on your current year’s tax return, or
      • 100% of the tax shown on your prior year’s tax return. (Your prior year’s tax return must cover all 12 months.)”

Speak to your tax advisor about estimated tax payments if you expect a large profit on the sale of a property.

How to Avoid Capital Gains Tax on Real Estate

No one wants to pay more taxes than they have to. But as a real estate investor, you have far more options than the average American to lower your taxes, at least on the profits from your investment properties.

Beyond owning the property for at least a year, try the following tax tactics to reduce or eliminate your real estate capital gains taxes entirely.

1. Avoid Capital Gains Tax on Your Primary Residence

When you sell a property that you’ve lived in for at least two of the last five years, you qualify for the homeowner exemption (also known as the Section 121 exclusion) for real estate capital gains taxes.

Single homeowners pay no capital gains taxes on the first $250,000 in profits from the sale of their home. Married homeowners filing jointly pay no taxes on their first $500,000 in profits.

You don’t have to live in the property for the last two years, either. Any two of the last five years qualifies you for the homeowner exclusion.

Consider doing a live-in flip, where you live in the property for two years as you renovate it, then sell it for a profit. It makes for a fun way to house hack, if you’re handy and enjoy fixing up old homes.

Alternatively, you could house hack a multifamily property, then either sell it after two years or keep it as a rental. Either way, you get to live for free and pay no real estate capital gains taxes! Toy around with our house hacking calculator to plug in any property’s cash flow numbers.

You can use the homeowner exemption repeatedly, moving as frequently as every two years and avoiding capital gains taxes. But you can’t use it twice within a two-year period.

2. Check If You Qualify for Other Homeowner Exceptions

Had to move in under two years? You may still qualify for a partial exemption from capital gains taxes on your primary residence.

The IRS offers several exceptions for homeowners who were forced to move, whether for a change of job, health issue, or other unforeseeable events. If you lived in the property for less than two years and were forced to move, speak with your accountant about any partial capital gains exemptions you might qualify for.

3. Raise Your Cost Basis by Documenting Expenses

Here’s a quick terminology lesson for non-accountants: your cost basis is what you paid for a property or other asset, including renovation costs.

Say you buy a property for $100,000, put $40,000 of repairs into it, then sell it for $200,000. You’d calculate your profit by subtracting your $140,000 cost basis from your $200,000 sales price, for a taxable profit of $60,000. (In the real world you’d have all kinds of other deductible expenses, such as the real estate agent’s commission, but they distract from the point at hand so we’re ignoring them.)

It’s easy enough to keep your receipts, invoices, and contracts when you’re flipping a house over the course of a few months. But what about when you own a rental property for 30 years? All those receipts, invoices, and contracts tend to get lost over the years, but they can help lower your capital gains tax bill when it comes time to sell.

The cost of every “capital improvement” you make to the property can add to your cost basis, reducing your taxable gains. Returning to the example above, you buy a rental property for $100,000, and over the next 30 years you pay $500 here and $1,500 there in capital improvements such as new windows, roof repairs, kitchen updates, landscaping, new driveways, and so forth. It adds up to $40,000 in total capital improvements, but it’s spread out over 30 years.

When you sell the property for $200,000, you can raise your cost basis by that $40,000 and pay capital gains on $60,000 rather than $100,000 — but only if you kept all those receipts and invoices. Save digital copies of all cost documents in a folder specifically for that property that you can pull up when it comes time to sell. It can save you tens of thousands of dollars in taxes!

As a seasoned real estate professional with extensive knowledge in investment strategies, taxation, and property management, I bring firsthand expertise to the table. I have successfully navigated the intricacies of real estate transactions, optimizing returns and minimizing tax liabilities for myself and my clients. My in-depth understanding of the concepts discussed in the provided article reflects a comprehensive grasp of real estate dynamics and the associated tax implications.

The article delves into the realm of real estate capital gains taxes, emphasizing the importance of strategic planning to mitigate tax liabilities. Let's break down the key concepts and provide additional insights:

Capital Gains Taxes on Real Estate:

1. What Are Capital Gains Taxes on Real Estate?

  • Explanation: The IRS imposes taxes on profits from selling assets, including real estate. Capital gains are calculated by subtracting the cost basis from the sale price, with adjustments for expenses.
  • Expert Tip: Increasing your cost basis by documenting expenses can reduce taxable gains.

2. How Much Is Capital Gains Tax in Real Estate?

  • Explanation: Tax rates vary based on the duration of ownership. Short-term capital gains (held for less than a year) are taxed at regular income tax rates. Long-term capital gains (held for at least a year) have lower tax rates.
  • Expert Tip: Holding assets for at least a year can significantly lower capital gains taxes.

3. Short-Term vs. Long-Term Capital Gains:

  • Explanation: Short-term gains are taxed at regular income tax rates, while long-term gains enjoy lower tax rates. The article provides tax brackets for both scenarios.
  • Expert Tip: Long-term investments offer tax advantages due to reduced tax rates.

4. Capital Gains Tax on Home Sales vs. Rental Properties:

  • Explanation: Homeowners can qualify for an exemption on capital gains tax, while landlords do not. Homeowners may avoid tax on the first $250,000 or $500,000 (for married couples) of profits from selling their primary residence.
  • Expert Tip: Real estate investors can explore alternative strategies to minimize tax liabilities.

5. When Do You Pay Capital Gains Tax on a Home Sale?

  • Explanation: Capital gains taxes on property sales are typically paid with annual tax returns. Failure to make estimated tax payments throughout the year may result in IRS penalties.
  • Expert Tip: Consult with a tax advisor for proper planning if anticipating significant profits.

Strategies to Avoid Capital Gains Tax on Real Estate:

The article suggests various strategies to reduce or eliminate capital gains taxes:

  1. Avoid Capital Gains Tax on Your Primary Residence:

    • Explanation: Homeowners can use the Section 121 exclusion to avoid taxes on the first $250,000 or $500,000 of profits by meeting residency requirements.
    • Expert Tip: Leveraging this exemption through strategic property ownership can yield tax advantages.
  2. Check If You Qualify for Other Homeowner Exceptions:

    • Explanation: Homeowners forced to move may qualify for partial exemptions. Consultation with an accountant is recommended.
    • Expert Tip: Understanding and utilizing available exceptions can optimize tax outcomes.
  3. Raise Your Cost Basis by Documenting Expenses:

    • Explanation: Keeping records of property-related expenses, including renovations and improvements, can increase the cost basis and reduce taxable gains.
    • Expert Tip: Maintaining organized documentation is crucial for long-term capital improvements.

These insights provide a comprehensive overview of the article's content, demonstrating a thorough understanding of real estate capital gains taxes and effective strategies for investors.

Capital Gains Tax on Real Estate – And 14 Ways to Avoid It (2024)

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