Capital Gains Tax Explained

When you are selling your house, you may be exposed to capital gains tax on the property as a form of income tax. The profit you make when you sell a property, including any business, investments or home, is included in your income each year in the form of a capital gains consideration. Each sale is in a unique category, so real estate capital gains are separate from capital gains on stock. As a result of the tax on this income, you may see a reduced down payment pool for the purchase of your next property. There are several ways to handle the capital gains consideration to prevent this.

Deferred Tax Options

One way to help reduce the expense of capital gains taxes is to seek tax deferral. Deferral means, ultimately, you will have to pay taxes on the earnings. However, you will not have to pay these taxes until you actually receive the cash in your pocket. So, if you place the cash in trust or immediately into a new investment, you will not incur the tax this year.

One option is a Deferred Sale Trust. Here, you place all earnings into a trust account and pay taxes according to a schedule set up with the trust. This option may be a good choice for an individual who is downsizing to a smaller home or not purchasing a new property immediately. If you are purchasing a new property with the profits, you may consider a 1031 exchange. This allows you to use the profits from the equity in your previous home to place a down payment on the new home. Since the money never reached you, you will not have to pay tax immediately. Instead, the tax will be deferred until you sell the new property and collect a profit.

Capital Gains on Secondary Properties

If you have sold your secondary property for a profit, you may be able to defer taxes until a year when you have a capital loss. This is not possible with a primary residence. However, with a home you are not living in, you can treat all capital gains and losses on properties as one collective pool. For example, if you net a 20 percent profit on the sale of a condo this year, you can hold that profit in trust. Then, if you later sell a condo for a 15 percent loss, you can use the two to offset, paying taxes in the same year. You will owe taxes on only a 5 percent gain instead of the original 20 percent gain. 

Deferring capital gains in order to offset them is a standard practice in real estate investing. To do this well, it is advisable to set up an LLC or other form of corporation to own all the properties. In this manner, you will not personally be responsible for the capital gains taxes of each of your properties. Instead, the business itself will be held liable for making any payments, and structuring taxes can be streamlined.