Strategies to Reduce Tax Burden When Selling Your Home for Cash

Let’s face it: nobody enjoys paying taxes, especially when selling a home. Losing a considerable portion of your income to various taxes, such as FICA, federal, state, and municipal income taxes, might impede your path to financial independence, especially at a young age. While depreciation and recapture can help to defer and decrease taxes while selling a home, the ultimate goal is to identify strategies to avoid or minimize the overall tax burden. Here are the most effective strategies to reduce tax burden when selling your home for cash to we buy houses Clayton County corporations.

Strategies to Reduce Tax Burden When Selling Your Home for Cash

Long-Term Ownership 

It’s a fundamental rule: If you owned your home for one year or less and then sold it, your capital gain is short-term, and you’ll be taxed at your ordinary income tax rate. However, if you have owned your home for over a year, your capital gain above the exclusion is long-term. (1)  The essential point here is to resist the desire to sell my house fast in Clayton, NC. Instead, keep the property as a rental for at least one year. 

During this time, your tenants can help pay down the mortgage while you wait for the property’s value to increase. If you’re concerned about potential damage to a newly renovated property, consider purchasing a rental property with existing tenants, allowing them to stay for a year or until they move out, and then proceeding with the renovation and sale.

Utilize a Section 1031 Exchange

Section 1031 of the tax code allows real estate owners to defer paying capital gains taxes by selling a rental property while purchasing a like-kind property and paying taxes only after the exchange is completed. Legally, the phrase “like-kind” is extensively defined. A property owner does not need to swap one unit for another or one business for another. As long as both homes generate cash as rental units, they are fair game. 

However, timing is critical with this strategy because investors have only 45 days from the date of the property sale to discover suitable replacement properties, which must be formally closed on within 180 days. And if a tax return is due (with extensions) before those 180 days, property owners have to close even sooner. Those who miss the deadline are required to pay full capital gains taxes on the sale of the original rental property.

Leverage Section 121: Primary Residence Exclusion

Selling your primary residence is more tax-efficient than selling a rental property for profit. IRS Section 121 permits individuals to deduct up to $250,000 of the proceeds on the sale of their primary house if they are single and up to $500,000 if they are married and filing jointly. To qualify, investors must have resided in their property as their principal residence for at least two of the five years preceding the sale. However, the years spent in a personal residence do not have to be sequential. 

As a result, some investors decide to convert rental houses into their personal residences. The deduction amount is determined by how long the property was rented vs used as a principal residence. Furthermore, a taxpayer cannot exclude the portion of the gain that was previously attributed to a depreciation deduction. This is known as depreciation recapture, and it only applies to rental properties. 

The amount previously claimed as a depreciation deduction is taxed at a recapture rate of 25%.

Timing Sales Based on Income Fluctuations 

Selling a property during a low-income year can be advantageous since, with lower income, you may not incur capital gains tax. For example, if you are single and your adjusted gross income is less than $44,625, or married and your adjusted gross income is less than $89,250, you may be able to avoid paying capital gains tax. If you are facing financial difficulties in a specific year, selling the property during that time may assist you in saving money on taxes.

Tax Loss Harvesting

Tax-loss harvesting is the technique of decreasing tax exposure when selling a rental property by combining the gains from the sale with a loss from another investment. This can be a tax planning approach if an investor holds an investment that has lost value (an unrealized loss) and decides to sell my house fast Clayton, NC at a loss in the same year as the gain from the sale of a rental property. Although this tax-cutting strategy is typically used to offset gains from stock investments, more people are increasingly applying it to rental real estate property sales. For example, suppose an investor made $60,000 from the sale of a rental apartment this year.

They also have a $85,000 stock market loss that has yet to be recognized. To fully balance the $60,000 in capital gains, the seller can sell a portion of their holdings for a $60,000 loss.

Invest in Self-Directed IRAs 

Consider buying and selling properties through a self-directed IRA or a Roth IRA, which allows you to reinvest the proceeds continuously. Traditional IRAs will be taxed on gains when withdrawn in retirement, whereas Roth IRAs enable tax-free withdrawals. Setting up a self-directed IRA, in addition to property management and sales responsibilities, can be time-consuming and costly.

Timing Sales Based on Income Fluctuations

Selling a property during a low-income year can be advantageous since, with lower income, you may not incur capital gains tax. For example, if you are single and your adjusted gross income is less than $44,000, or married and your adjusted gross income is less than $89,000, you may be able to avoid paying capital gains tax. If you are facing financial difficulties in a specific year, you should sell my house fast Durham during that time. This can assist you in saving money on taxes.

Document Capital Improvements 

Maintain precise records on capital improvements, which are upgrades that extend a property’s life. According to the IRS, these upgrades enhance the cost basis of your property, which is effectively the amount you paid for it. For example, if you bought a home for $200,000 and sold it for $250,000, you would usually owe capital gains taxes on the $50,000 profit. However, if you spent $15,000 on a new roof during your ownership, your cost basis would rise from $200,000 to $215,000. 

As a result, you’d only pay taxes on a $35,000 gain. This method requires accurate record-keeping to be effective.

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