This week I discuss what you need to do once you decide to sell an investment property and how to avoid taking a hit with capital gains tax.

If you own an investment property of any kind at any time, you will face a time where you’ll need to or want to sell your property.

Selling an investment property for profit will incur a significant capital gains tax. This gain must be claimed on your taxes in the year the property is sold.

It’s important that you know what the tax cost will be, and to keep in mind that each state has its own state tax on top of the federal tax.

The whole purpose of investing is to make money from your property and not lose it! So you’ll want to find a way to save as much money as you can from the sale. That’s why you should make sure you retain a good tax advisor when you are dealing with an investment property.

Understand Your Goals

How you deal with the capital gains tax and the strategies you choose will depend on your goals for the sale of your property. Here are some possible scenarios for selling:

• You want to buy another rental property that is a better investment opportunity, whether it is to take advantage of the increased value of the current home to buy another or change locations of your investment property and look elsewhere.
• You want to cash out and stop investing in rental properties, whether due to an upcoming retirement or you no longer want to be a landlord.
• You want to sell your fix-and-flip for profit to buy another one.

As you can see, there are several reasons you might want to sell an investment property. Let’s take a look at what options you have to help save you some money and mitigate your taxes with this sale.

Defer Capital Gains Tax with 1031 Exchange

You can defer the capital gains tax with a 1031 Exchange only if you aren’t planning on cashing out on the property, but rather buy a “like-kind” investment property.

Section 1031 of the IRS Tax Code allows an investor to reinvest the profit from the sale of their investment property only into another investment property that is at least equal value. No gain or loss is recognized until this next property is sold.

“Like-kind” property exchange is an option for single-family, multi-family, vacation property, and land, in addition to commercial property and build-to-suit.

To qualify for the 1031, you must identify the new property within 45 days once you have transferred your current property, and the exchange must take place with 180 days. There is no limit in how many times you can transfer from property to property; the tax will be due once you sell a property and cash out.

You can use the 1031 Exchange for continuing to buy rental property after rental property. It can be a way to find better investment properties, helping you to boost your rental income. Plus, you won’t have to come up with a down payment and will avoid the capital gains tax each time.

Keep in mind, you can experience a “gain” even if you are experiencing a “loss” with an investment property. The IRA considers the debt on a property to be its sales price when the debt exceeds the sales price. So if the debt exceeds the basis (purchase price + improvements – depreciation) on an investment property, there’s still a gain.

For fix-and-flip investors, the 1031 Exchange may be used if they want to buy another property. However, they won’t have access to any profit from the sale to use in another way (pay off contractors or credit card bills, etc). To benefit from the Exchange, some investors turn their fix-and-flip into a rental for a year or so, and report that on their taxes, claim the income and expenses, and then list it.

Another Option to Avoid Capital Gains Tax

What happens if you don’t want to buy another investment property and then can’t take advantage of the 1031 Exchange?

One option for saving money at tax time is to convert your rental property into your primary residence before you sell. This doesn’t work for everyone, and you also must meet certain requirements for it to be considered a primary property.

As pointed out earlier, when selling your primary residence rather than an investment property, you’ll face a better tax situation. But to qualify, you must prove that you have owned the home for at least 5 years, and lived in it for at least two of those five years. How long you live there will impact your taxes.

Here’s Where I Can Help!

Selling an investment property and making sure it’s done right requires a certain expertise.

Not only do you need a good tax advisor to come up with a strategy for any capital gains tax, you want to have a real estate agent who understands how to make the selling process as smooth and as profitable as possible.

I’m here to help you make this sale go as planned and I’ll accomplished this by:

• Using my knowledge of the local real estate market and understanding how and when properties like yours are selling well.
• Determining the best price for your property that reflects the market value and comparables in the neighborhood so that you draw in buyers and make a profit.
• Creating a strategic marketing plan once we know who your buyer is — another landlord interested in attracting similar tenants or a certain type of buyer who will live in the home.
• Making sure we time it all right so that you take advantage of the flow of the market and potential buyers.
• Working with your goals and making sure we meet them, whether it’s to find another investment property for the 1031 Exchange or to cash out on the property.
• Referring you to a professional CPA, attorney and financial advisor who specialize in helping real estate investors keep more of their profits. 

If you have an investment property you’ve been thinking of selling, let’s talk and make a plan.  You could save a huge portion of your profits just by planning a little in advance and talking to the right experts who can help you.