Capital Gains Tax in Real Estate Explained and How to Put Off Paying Taxes
Capital gains taxes cost a lot in taxes but they don't have to. We are going to look at what you need to know about capital gains taxes AND how you can put off paying for them for many years to come.
Capital gains tax is the rate of tax you must pay when you sell an asset and is taxed on the profit you made. If you bought a house for $100,000 and sold it for $200,000, then you made a profit of $100,000. That $100,000 is taxed by the government in the form of capital gains.
Now lets look at everything you need to know about capital gains tax.
I want to share with you everything you need to know about the capital gains rate, and the tax breaks that are available exclusively to you as a real estate investor.
Capital Gains Tax vs. Income Tax
We actually get charged a lot when we’re making money—it almost feels like a penalty. So, if you’re working a job, you’re getting taxed at a certain level or percentage.
If you purchase an investment property, when we buy one rental property as investors in real estate, we get taxed for much less than we would if we were working a J.O.B, or a “Just Over Broke” job.
If you aren’t investing in rental properties, your earned income taxes will be higher than your capital gains taxes, perhaps even doubled.
The Tax Benefits Exclusive to Real Estate Investors
Right now, capital gains taxes are around 15%, which is a favorable number for us investors. I get taxed 15% on the money that my properties currently generate.
If you’re still working that Just Over Broke job, you get penalized far more with federal income tax rates starting at a minimum of around 28%. Your tax rates could reach as high as 40-45%.
It’s absurd how much money you can lose to taxes. And that’s just another reason why I love investing in real estate.
Among all the perks of investing in rental properties—making at least $250 in passive income, having tenants pay off my mortgage and related expenses, etc.—another one of those great advantages are the tax benefits that I receive when I invest in just one rental property.
Capital gains on your rental property work like this: if you buy a house at a certain price and it appreciates over time, you’re only taxed on that increase.
Let’s say you buy a house for $200,000 and it appreciates to $300,000. You will not be taxed on the $300,000 total post-appreciation, only the on the $100,000 increase itself.
How I Get My Tenants to Pay for My Business Expenses
As a disclaimer, I’m not an accountant, but I’ve been given this information by my personal accountant. That’s just another great reason about owning real estate is that I work so little.
I simply hire my accountants, property managers, realtors, inspectors etc. to do the work for me.
And guess what? I’m not even the one paying them, my tenants are.
By accounting for all those extra expenses in advance, everyone I hire to do the work for me gets paid through my passive income.
By making sure I rent a property for more in order to hire professional help, that passive income that I make, which is always $250 or more per each property, I can then account for the cost of my accountant.
If you guys know me, I’m really not good with numbers. It really is in one ear and out the other. Math is not my strong suit.
But even though I’m horrible with the bookkeeping side of real estate investment, I can have a professional accountant handle that side of business management at no cost to me whatsoever.
I just give them my paperwork and they do the rest.
Feel free to talk to your own accountant to figure out exactly how to best utilize all this information on taxes as well as how to manage your depreciation, capital gains, etc.
In the meantime, I’m just going to give you some tips that will help you once you do go meet with your accountant.
Capital Gains Tax & Rental Properties
Let me dive a little deeper into how the capital gains tax works on a rental property.
Say when you buy one rental property, you purchase the house for $100,000 but then you have other hidden expenses to deal with like closing costs, lender fees, mortgage fees, cost to renovate, etc.
Once you add all those additional fees in, you’ve now put $150,000 into this piece of property.
After spending that $150,000, you can go and sell that house for $200,000 and you’ll only be taxed on that increase in price, which in this scenario is that $50,000.
Since you’re not being taxed on the entire value, you can actually deduct all of your expenses. Isn’t that fantastic?
Even your business expenses can be written off in your capital gains tax rate. Capital gains is seen as a business by the IRS, so they want to tax you at a lower rate, which at the moment is a phenomenal 15%.
To put it into perspective, if you’re make $100,000 through real estate investment, you’re only going to be pay $15,000 in taxes.
That's as opposed to if you’re still working at an hourly rate and thus paying income taxes.
So if you're also make $100,000, you’ll be paying 30% give or take, and it might be higher or lower depending on your personal write-offs. $15,000 versus $30,000-$45,000 is a huge difference.
As real estate investors, we have the unmatched advantage to be taxed at a much lower rate.
For all of my fellow investors that want to make sure they're reaping the benefits of this advantage through capital gains, I have a few pointers for you all.
That one rental property you have basically equates to one business. That one business itself already has so many tax deductions included. Depreciation comes into play here.
In fact, I was just talking to someone today about real estate and depreciation came up.
He said, “Don’t you get hit with a lot of taxes?”
And I said “No, I actually don’t. It’s actually crazy how little I pay in taxes because of depreciation.”
So, here’s how it works. If you, for example, have a house that you bought for $100,000, you’re going to depreciate that over 27 and a half years.
If you made $100,000 in profit off of that house when you depreciated that out over those 27.5 years, to the IRS it will look like you made maybe $95,000 instead of $100,000.
And if you have more than one property, it might even look like $90,000 or even $85,000 to the IRS. The IRS in turn give you the benefit of the doubt all thanks to depreciation.
When you pay your capital gains tax rate and you’re paying your taxes over and over again, you’re depreciating that out, so you’re therefore paying less in taxes because of depreciation.
Talk to Your Accountant!
There is one caveat to be aware of with depreciation, however.
When you eventually sell the property, the IRS recoups all of that depreciation.
You’re not going to get taxed all at once necessarily, but it’s important that you talk to your accountant first when you’re thinking about selling your rental properties.
When you go to sit down with your accountant, you might be thinking— “How much am I going to be paying back in taxes to catch up with that depreciation?”
I would say there’s a 1031 exchange. You don’t even have to worry about that depreciation when you sell a house if you transition that property money into a brand-new property.
By doing so, you defer your taxes!
Check out this article to learn more about a 1031 exchange in real estate.
Getting Out of Paying Capital Gains Tax if You’re Ready to Sell
I did also previously mention that I wanted to give you a quick way to get out of paying capital gains. It’s one of the questions I get asked the most.
And to tell you the truth, it’s going to be very difficult to get out of paying those capital gains taxes, but there are a couple of different way to try.
Number one is that 1031 exchange like I said. You “get out” of paying those capital gains by deferring them. You’re putting them off for a later date when you actually do sell your property.
Another tactic you can try is, if you leave anywhere close to your vacant rental property, you can literally move into that house and live in it for approximately 1-2 years.
Once you’ve lived in it for that period of time, you can sell it without paying that capital gains tax. Why is that? Because it’s seen as your personal residence and no longer an investment property, so you can possibly get those taxes written off.
Again, I’m not an accountant and definitely not a government official, so talk to your accountant for proper guidance and professional insights in regard to managing and hopefully writing off that capital gains tax that you’re going to have to deal in selling your rental properties.
In thinking about your capital gains tax, think about all those points we touched on like appreciation, depreciation, 1031 exchange, and the possibility of living in that rental property yourself to free yourself from those taxes all together.
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