When it comes to selling anything, you are likely aware that there will be taxes involved.
These taxes and the amounts of them change dramatically, depending on what type of building or investment is involved.
For instance, selling a rental property is a little bit different than selling a primary residence, but both are subject to capital gains tax.
If you don’t know what capital gains are, that is a profit you make off of selling an asset.
You must pay taxes on any capital gain.
In the case of rental property, there are a few things you must calculate, in order to determine the dollar amount of your capital gain.
Here's a quick rundown of our list:
- Capital Gain Rules
- Depreciation Taxes
- State Taxes
- 1031 Exchanges
- Living in Your Rental Property
- Other Types of Property
Capital Gain Rules
If you have owned your property for 1 year or more, it will be taxed as a long-term capital gain when you sell it.
This carries a standard tax rate of 15%, but if your income is high enough, you may have to pay a tax of up to 20%.
If you are subject to this 20% tax, you will also have to pay an additional Medicare tax as well.
Here is how to calculate the amount of capital gain.
First, take the amount of money you sold the property for and subtract it from the amount you paid for it.
Then subtract closing costs, and the amount of any major improvements you made.
Major improvements include things like new roofs and insulation. The number left is the amount of your capital gain and the amount you will be taxed on.
Be sure that you have receipts for all the renovations and upgrades you did to the property, since you never know when and if the IRS will require it.
If you have owned your property less than a year before selling it, it will not be taxed like a long-term gain, but it will likely be taxed at the same rate as your income.
Another tax you will have to pay to the federal government is called depreciation recapture tax.
While you own a rental property, you are allowed to claim its depreciated value each year on your taxes.
However, when the time comes to sell it, you have to pay back that amount.
You will have to pay this tax even if you never took advantage of this aspect of the tax law.
If you sell for more than the depreciated value of the property, you will have to pay 25% of the depreciated value as tax.
You can refer to Section 1250 of the tax code for more information.
When you live in San Diego, you will also be subject to California state taxes when selling your investment property.
The amount of tax you’ll pay for capital gains and depreciation will be the same percentage as what you’re taxed on your income, with a max rate of 9.3%.
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In order to lessen the burden of some of these taxes, many people opt to use 1031 exchanges.
What this means is that you immediately invest the money you make off the sale of your rental property into something else.
The most common way this is done is selling a property and then purchasing another similar investment property right away.
While this is subject to many rules and regulations, when executed properly, it keeps you from having to pay any capital gains tax.
Make sure you read up on Section 1031 of the tax code if you want to utilize this program or find out how you can qualify for it.
Check out our in depth article about San Diego 1031 IRC tax deferred like kind exchanges.
Living in Your Rental Property
Another way to save yourself money on taxes is to change what type of property you sell.
For example, a rental property that you have lived in for 2 out of the last 5 years is considered to be your primary residence and is subject to fewer taxes.
This is something to think about if you can live in this investment property, or you have lived in it for a period of time already.
The two-year requirement doesn’t have to be consecutive years.
Of course, this doesn’t help you if you have not owned the property for at least 5 years.
Check out our in depth article about San Diego capital gains tax on primary residences.
Other Types of Property
It is important to understand that other types of property carry different taxes when they are sold.
For example, if you sell your second home, you have to pay normal capital gains taxes.
Likewise, if you sell a vacation home, it works much the same way.
In both cases, you are unable to claim a loss.
For this reason, you should know exactly what types of property you own and what the laws are regarding them.
There are different capital gain tax limits, depending on how long you have owned it and if you have ever lived in it or not.
Always keep important documents and paperwork together on your properties, so you will have them when you need them.
When it comes to selling a rental property, there are stringent rules involving capital gains tax.
You will need to figure out what the capital gain amount is first, which is really the amount you sold it for, minus the purchase price, and the cost of any major improvements you made.
You will be taxed by the federal government and the state government, based on this number.
Additionally, you will have to pay depreciation taxes, since you are selling a rental property.
There are a few ways to offset the costs of some of these taxes, however, so you should not only conduct your own research, but you should also be aware of all the laws that may apply to you.
This will allow you to see all of your options and find out if you need to pay the full capital gains tax amount on your property, or if you can pair it with some other investment that is more advantageous to you.
What do you think?
Can you now think of some great strategies in which you can lower your property gains taxes?
Let me know in the comments below - or, call/text me at (760) 297-4539.
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