CPAs, investments professionals and realtors often talk in their own language and a term that flies around regularly is “capital gains.” Since many people have not yet embraced the world of investing, this term may be unfamiliar. We’re here to assist you demystify real estate speak while helping you potentially get the most out of your investment.
Capital Gains Taxes
First of all, let’s define the term capital gains taxes as it applies to real estate. Simply put, capital gains are the profit you realize (receive) on the sale of a real estate property. For example, if you purchase a home for $500,000 and you sell it for $600,000, your capital gains taxable amount is $100,000. Now what happens with that $100,000 depends on many factors. If you are simply moving from one principal residence to the next, capital gains aren’t as much of an issue as couples and individuals are exempt at $500,000 and $250,000 respectively. And home improvement costs can be added to further reduce the profit.
But, if you’re selling a non-principal residence property, i.e. a rental property, vacation home, etc., capital gains taxes are likely in your financial future. The amount you will be required to pay will be based upon a variety of conditions including your tax filing status, the amount of profit and others.
How to Avoid Capital Gains on an Investment Property by Reinvesting
The news isn’t all grim. There are ways to avoid a taxable event, while potentially making a profit. Enter the 1031 exchange – named for the Internal Revenue Code Section 1031 first introduced in 1921.
What is a 1031 Exchange?
A 1031 exchange is a tax break that allows you to basically swap an investment property for another one without paying capital gains taxes. Of course, this process comes with a few steps and rules, but followed correctly, this tool can help you defer those pesky capital gains taxes.
There are multiple investment options to consider when entering a 1031 exchange. They include: a Delaware Statutory Trust, an UPREIT, shared ownership (Tenants in Common), oil and gas royalties, a single-tenant triple net property (NNN) and Opportunity Zones.
Each of these investments potentially eliminates the need for day-to-day property management, allows property depreciation and a step-up in basis, defers capital gains taxes, and may provide passive investment income.
How can Diversified Investment Strategies Help?
Our team of experts can help you determine the appropriate investment strategy for your portfolio. Administered correctly, a 1031 tax-deferred exchange can be a powerful tool allowing you, the investor, to sell and buy like-kind property to defer capital gains tax while preserving the value of your property and hard-earned equity. We have administered hundreds of exchanges and are eager to help you with your unique situation. Contact for a complimentary consultation to find out what your investment options are.