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Published on: 07/05/2023 • 6 min read

How to Avoid Paying Capital Gains Tax on Property

Are you concerned about the potential financial burden of capital gains tax on your property investments? If so, you’re not alone. Taxes can be a significant expense for real estate investors, and it pays to know how to avoid paying capital gains tax.

Fortunately, there are various strategies that can help minimize or even work to eliminate capital gain taxes when selling rental properties or other types of investment real estate.

In this article, we will discuss how to avoid paying capital gains tax on property, by taking advantage of a few high-net-worth tax strategies, including exploring available exemptions and deductions, as well as methods like 1031 exchanges. By understanding these options and properly planning ahead, you can set yourself up to potentially keep more money in your pocket when the time comes to cash out your investments.

It’s important to note that while there are legal ways to minimize capital gains taxes on property investments, taxes cannot be completely avoided. Please consult with a qualified tax professional for the most accurate and up-to-date advice.

How to not pay capital gains tax on property in Texas

Fortunately for Texas investors, the state does not impose a state-level capital gains tax. Therefore, any Texas capital gains tax on real estate you’ll be liable for paying on your property investments will come from the federal government rather than the state.

This means that you’ll still need to be aware of potential liabilities from the Internal Revenue Service (IRS) both at the time of sale and during your ownership period. To make sure you’re not paying more than necessary for federal income taxes, contact an accountant or tax professional to review your individual financial situation and provide guidance.

Given that the sale of property and real estate can still be taxed by the IRS, the question “How do I avoid capital gains tax on the sale of my home or property?” still stands.

The following tax planning solutions can help you minimize taxes for capital gains on your home sale property investments:

1. Take advantage of exemptions and deductions

If you’re a primary residence owner, you may be able to qualify for the $250,000/$500,000 exclusion for single/married couples on the sale of your main home. Additionally, the IRS allows homeowners to reduce their taxable capital gains by deducting certain expenses such as points, taxes, and home improvements (e.g. installing energy-efficient equipment or renovations made for medical reasons).

2. Utilize a 1031 Exchange

A 1031 exchange (also known as a tax-deferred exchange) allows investors to defer capital gains taxes on selling an investment property by reinvesting the proceeds from the sale into a new like-kind investment property. This can also be a great way to potentially upgrade your investments and diversify your portfolio without incurring hefty taxes in the process.

3. Invest through real estate crowdfunding

While not typically tax-deductible, investing in real estate crowdfunding allows investors to spread their risk across multiple properties and benefit from professional asset management services, all while working to limit capital gains tax on each individual property that’s part of the portfolio. Since these funds are managed by professionals, they allow you to enjoy many of the benefits of owning rental property without having to become a landlord yourself.

How to avoid paying capital gains tax on inherited property

Not all investors come to property investments through buying and selling. Some come into real estate through transferring ownership of a property from parent to child or other family member. If you’ve inherited a rental property or another type of real estate investment, you may be concerned about avoiding capital gains taxes on the property.

The good news is that there are several strategies that can help you minimize capital gains taxes when inheriting property.

1. Take advantage of the IRS step-up in basis

If the inherited asset has increased in value since it was acquired by the deceased, you may be able to limit capital gains tax. This is because, according to the IRS, heirs receive a “step-up” in basis when they inherit an asset from a loved one.

A step-up in basis means that the beneficiary will now use the current fair market value as their cost basis for calculating capital gains taxes rather than what the original owner paid for the asset. Therefore, there is no need to pay taxes on any appreciation that occurred before inheritance.

That said, if you decide to sell the inherited property at some point and realize a gain (i.e., profit from selling above the fair market value), you may be liable for taxes on that gain. To avoid paying capital gains tax in this case, it may be better to hold onto the property and wait until a time when you need to sell for personal reasons.

Continue reading: Is real estate a good investment for retirement?

2. Utilize a charitable remainder unitrust (CRUT)

Another option to limit capital gains tax on inherited property is with a charitable remainder unitrust (CRUT). With this strategy, you can donate real estate in the form of an irrevocable trust and get an immediate tax deduction while working to avoid capital gains tax.

You can then designate family or other beneficiaries who will receive income from the trust for a specified period of time with the rest going to a chosen charity. When the designated beneficiaries receive the trust’s assets, any appreciation in value since it was donated is untaxed.

It should be noted that setting up a CRUT can be complicated and costly, so it’s always recommended to consult with an estate planning attorney and your financial advisor first before committing to this strategy.

3. Use a qualified personal residence trust (QPRT)

Using this strategy allows for an outright irrevocable gift of a personal residence to the trust, while preserving the right to stay in the home for a period of time. This allows for future appreciation beyond the year in which the home is gifted to take place outside of the estate. 

The beneficiaries of a QPRT are usually children or relatives, thereby leaving them with the full value of the property after the term for the original owner to stay within the residence expires.

Wanting to better understand the implications of capital gains tax on your investments? Let’s talk.

Taxes can be a significant burden on property investors, but there are ways to minimize them if you know how to avoid paying capital gains tax. With careful planning and a proper understanding of the tax regulations, you can put strategies in place that work to keep more funds in your pocket when it comes to cashing out.

If you have questions about investing in real estate vs. stocks or would like to learn more about the tax implications of investment properties and their impact on your financial plan, Avidian Wealth Solutions has the experience to help.

We are a Houston-based fiduciary wealth management firm offering tax planning in Houston, Austin, and around Texas. Our advisors can help you understand the tax codes so that you can make better-informed decisions for your individual financial situation and vision.

Schedule a conversation with us today to get started!

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