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BlogArrowBusiness ManagementArrowHow to Minimize the Tax Bite When Selling Your Investment Property
Business Management

How to Minimize the Tax Bite When Selling Your Investment Property

Amanda Han
Expertise: Business Management, Real Estate Investing Basics, Personal Finance, Personal Development, Real Estate News & Commentary, Mortgages & Creative Financing
107 Articles Written
minimize-taxes-sell-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.

Related: The Ultimate Guide to Real Estate Investment Tax Benefits

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.

Seller Financing

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.

Related: Your Guide to the Tax Treatment of Closing Costs: A Line-by-Line Look at the HUD-1

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!

By Amanda Han
Amanda is a CPA specializing in tax strategies for real estate, self-directed investing, and individual tax planning with over 18 years’ experience. She is also a real estate investor of over 10 ye...
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Amanda is a CPA specializing in tax strategies for real estate, self-directed investing, and individual tax planning with over 18 years’ experience. She is also a real estate investor of over 10 years with a focus on long-term hold residential and multi-family assets across multiple states. Formerly a tax advisor at the prestigious accounting firm Deloitte in the Lead Tax Group, focusing on tax strategies for the real estate industry and high net worth individuals, and at an international Fortune 500 Company in the high-tech industry in the Corporate Tax department, Amanda’s goal is to help investors with strategies designed to supercharge their wealth building. Amanda’s highly rated book Tax Strategies for the Savvy Real Estate Investor is amongst Amazon’s best seller list. A frequent contributor, speaker, and educator to some of the nation’s top investment and self-directed IRA companies, Amanda has been featured in prominent publications including Money Magazine, Realtor.com, and AllBusiness.com. Amanda was a speaker at Talks at Google and is a 40 under 40 honoree by CPA Practice Advisor, showcased amongst the best and brightest talent in the accounting profession. Her firm Keystone CPA, Inc. was awarded a two-time winner of the Top CPA of Orange County Award by OC Metro Magazine. She is certified by the CA State Board of Accountancy and is a member of the prestigious American Institute of Certified Public Accountants (AICPA) with clients across the nation.
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8 Replies
    David Faulkner Investor from Orange County, California
    Replied over 5 years ago
    Great points! Personally, I prefer to hold and cash out refinance if I want to pull money out, since selling is such an expensive transaction in both taxes and realtor commissions (another 6%). I thought about 1031, but the main problems I see is you sell into a hot market, but then you also have to buy into a hot market and have a limited time to do so. Finally, seller financing is a great idea, but be careful to use a Mortgage Originator who is licensed in that state to create the note and then board the note with a licensed servicer. This will incur some expenses, but the new Dodd-Frank regulations are no joke and this helps ensure you are compliant. Also helps get top dollar if you ever choose to sell the note you created at a later date.
    Amanda Han Accountant from Fullerton, CA
    Replied over 5 years ago
    Thank you for sharing what you did David!

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    Kevin Yoo from San Diego, California
    Replied over 5 years ago
    Does anyone know what to do if you bought an investment property into an LLC and then want to do 1031 exchange? Do I have to deed the property out of the LLC into my name to make this work?
    Bryan Otteson
    Replied over 5 years ago
    AFAIK, the 1031 exchange must remain in the same name. If you bought in an LLC, the new property within the exchange must be in the same LLC.

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    Nattapon Permchom Investor from Columbia, South Carolina
    Replied over 5 years ago
    What about depreciation recapture in 1031 exchange, will it be deferred too?

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    Louis A. Investor from San Marcos, California
    Replied over 5 years ago
    Good article — Thanks for positing. Just 1 clarification regarding primary turned rental …. I was always under the impression from my CPA that you were required to live in the property 3 of the last 5 years in order to be exempt from paying tax. Your article suggests 3 of 6 years. Appreciate if you would confirm. Thanks again! Louis A. ************************************ ” 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.”
    Shaun Reilly Landlord and Rehabber from Newton, Massachusetts
    Replied over 5 years ago
    I believe that the problem here is that the requirement is only to have had it as a primary for 2 out of 5 years. So her example basically gives you a little cushion. Here is something from the IRS saying the basic conditions needed. http://www.irs.gov/taxtopics/tc701.html

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    Michael Sandvig Investor from Denver, Colorado
    Replied about 1 year ago
    what proof does the IRS require to show that you lived in the home as your primary residence for 2 of 5 years? example: I bought a townhome in aug 2015, lived in it for just over a year until oct 2016 and began renting it out until moving back in feb 2018, treating as my primary residence for another year, until feb 2019 - if i sell before aug 2020 do i qualify for the capital gains exemption?

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