How to Minimize the Tax Bite When Selling Your Investment Property
Just like summertime in Las Vegas, the real estate market has been Hot Hot Hot! With the summer months approaching, we are meeting with more and more clients that are looking to take advantage of the market while it is on its way up. Whether it’s buying more properties, selling existing properties, or refinancing to take some cash out, there has been an extraordinary increase in real estate transactions in recent months.
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If you are planning to sell your property and you have a healthy gain built up in your real estate, here are some strategies that can potentially help you to minimize the tax bite.
Consider a 1031 Exchange
If you are looking to dispose of a rental property and plan on reinvesting the proceeds into another real estate deal, consider the possibility of doing a 1031 exchange in order to defer the taxes. Simply put, a 1031 exchange is a tax loophole that allows you to sell one property and defer payment of taxes on the gain. It is possible to sell a rental property and use a 1031 exchange to buy another rental property free of taxes. It is also possible to sell a residential property and defer the taxes when you purchase a commercial building.
There are rules and qualifications to follow in order to get this tax benefit, but if implemented correctly, a 1031 exchange can help you to not only defer taxes, but may also allow you to ultimately wipe out the tax on your real estate gains.
Selling a Rental That Was Your Primary Home
If you turned your primary home into a rental property, then you may be able to use the primary home exclusion to avoid taxes. For example, if you lived in your home for three years and then decided to keep it as a rental for another three years, it is possible to sell the rental property and be able to exclude up to $250k or even $500k (if you are married) of gain free from income taxes.
If you are someone who has kept your home as a rental and are now getting close to the three year mark, now is definitely the time to meet with your tax advisor to strategize on the pros and cons of selling that rental property. In fact, I recently met with a client whose home in California has gone up close to $120k since she purchased it. If she decides to sell it before this August, she could save up to $36k in total capital gains taxes.
If you are looking to sell your property to lock in today’s market price but do not necessarily need the money, then consider doing seller financing. When you enter into a seller financing deal, it is an executed sales contract in that your buyer has locked into a purchase price at today’s higher market value. However, on the tax side, you do not necessarily need to pay taxes on the full gain of your contract. Instead, in a seller financed deal, you can defer the taxes on your gain over time each year as you collect your payments.
Don’t Sell It
Selling isn’t the only way to take money out of your real estate deals. A perfectly good way to do that is to simply refinance and pull the cash out. For example, if you purchased your rental for $100k with a $20k down payment but it is now worth $180k, it is possible to refinance and pull out an additional ~$64k of cash with traditional bank financing. This may be a good time to use this strategy in today’s climate because of the currently low interest rate.
If you are able to do a low cost refinance, lock in a low 30 year interest rate, and use the loan proceeds to invest in other properties, you may be able to supercharge your wealth building. Another added benefit of keeping the property and refinancing it is that with refinance, you are generally pulling out the cash free of taxes. So instead of paying Uncle Sam, you can use 100% of your loan proceeds for your next deal. Depending on what you use your loan proceeds for, it may be possible to write off the interest on that loan as well in future years.
When the market is hot, we need to be proactive about what investment decisions we make. Whether it is to cash out, trade up, or buy more, make sure that you work with your team of advisors so that you can make the most well informed decision to supercharge your wealth and keep more of your bottom line.
Investors: What strategies do you use to minimize taxes when selling property?
Leave your questions and comments below!