4 Ways to Reduce the Tax Hit When Selling a Rental Property
Investing in rental properties can be an incredible way for investors to build long-term wealth and enjoy substantial passive income. Investors may eventually choose to sell a rental property at some point for a variety of reasons, and this sale can produce a substantial windfall of cash. However, Uncle Sam will want his share of that money and you’ll need to plan proactively to reduce your tax bill and hold onto your hard-earned money. Below are 4 ways to reduce your tax bill when selling a rental property.
Tax Loss Harvesting
By planning sales of stocks or other assets strategically, you can use the losses from one asset to offset the gains of another. For example, say that you sold a rental property at a $50,00 gain during the year. Let’s also assume that you own stock in XYZ company that is down $50,000 from the time you bought it. By selling the XYZ company stock before the end of the year, you can offset the capital gain from the sale of the rental property and pay no additional taxes.
Utilize the Primary Residence Exclusion
The sale of a primary residence is taxed much more favorably than the sale of a rental property, and will allow you to exclude either $250,000 (single filers) or $500,000 (married filers) of the capital gain from taxation. To take advantage of this significant tax savings opportunity, you will need to own and live in the house for at least 2 out of the last 5 years before you sell the property.
Short vs Long Term Capital Gains
If you have bought a property recently and plan to sell it within 1 year, it will be taxed at short term capital gains rates rather than long term capital gains rates. Postponing the sale if needed to make sure that you’ve held it for at least 1 year before closing can have a big impact on reducing the eventual tax bill.
How Does a1031 Exchange Work?
Real estate investors can also defer taxes by using a 1031 exchange. To complete a 1031 exchange you must reinvest the proceeds from the property that was sold into a new rental property. Timing is key with this method, as you must identify the new property within 45 days and close within 180 days of the sale of your previous rental property.
