One of the downsides of investing in property is the burden of paying too many taxes. Aside from paying sales tax, property tax, income tax, investors must also pay capital gains tax for their personal and investment assets. Those involved in selling assets like real estate must pay capital gains tax on some of the proceeds of the sale. Since it can go as high as 39.6%, finding ways to avoid paying capital gains tax or minimising its cost could go a long way.
What is Capital Gains Tax?
Capital gains tax is what an individual owes the government when the sales price received from the asset is greater than the basis in the asset. The “basis” refers to the original price paid for the asset. However, individuals who made improvements to the assets, the cost of improvement increases the basis. If the asset depreciated in value, the basis decreases also.
Ways to Avoid Capital Gains Tax Payments
Fortunately for investors, there are various ways and means that can effectively reduce or lower capital gains tax that they have to pay. This includes:
Sell the Property After a Year or Longer
Capital gains will qualify for long-term status then the asset in question is sold after a year. Long-term capital gains mean paying for lower capital gains tax rate. It will become even lower if it is longer than one year. Note that marginal rates of 10% to 15% have a 0% capital gains rate. Marginal rates of 25%, 28%, 33%, or 35% have a capital gains rate of 15%, and a marginal rate of 39.6% pay capital gains rate of 20%.
Sell When You Have Low Income
Remember that the long-term capital gains rate depends on the marginal tax rate, which is determined by your income. To lower your capital gains rate, sell only when you have low income. Individuals will make money if they sell their assets during their lean years – a time when they really need the money.
Lower Your Taxable Income
As mentioned, the capital gains rate depends on the individual’s income. So applying general tax-saving strategies will also help lower capital gains tax rate. One way to do this is by maximising credits and deductions before filing a tax return. Donating cash and goods to charity is also applicable.
Keep Home Improvement Records
Home improvements over the years are included in the basis of a property. A higher basis means lesser capital gains tax when selling. Any improvements to a home to improve it or restore it is one way of reducing your capital gains tax. This benefits sellers when the gain is greater than the exclusion amount for which they qualify or if they do not qualify for the ownership and use tests.
Since the amount is dollar for dollar, keeping a record and all copies of receipts of all improvement and purchases made will be beneficial.
In the US, the IRS capital gain exclusion is sufficient enough. As a result, most sellers never have to pay taxes on the sale of their properties. However, those who have held onto the property for quite some time, the exclusion may not be enough to cover the gain. To maximise the capital gain exclusion, moving often may be the solution. Living in the house for at least two years may be enough as the IRS allows individuals to use the exclusion several times once every two years. This means a seller can several homes at a large gain and never have to worry about paying taxes.