Published on: 12/07/2023
Texas Capital Gains Tax on Real Estate Explained
In the world of wealth and investment management, understanding the implications of the Texas capital gains tax on real estate is absolutely essential, as it can affect your net profits as a real estate investor or homeowner.
Additionally, if you’re hoping to pass down real estate to your loved ones, the capital gains tax may apply to the increase in the property’s value from the time it was inherited to the time the inherited property is sold, requiring them to pay taxes on gains that they may not have expected.
While the Texas capital gains tax on real estate does not exist, your real estate may still be subject to federal capital gains tax. Having a better understanding of the laws surrounding capital gains can allow you to better plan for future asset transfers while working to preserve the value of your estate.
What is the capital gains tax?
Simply put, the capital gains tax is the tax paid on the profit earned from selling a capital asset such as real estate. This includes properties like land, houses, commercial buildings, and even investments in stocks or bonds. The profit is determined by subtracting the original purchase price of the asset from the final sale price. For example, if you purchased a property for $200,000 and sold it for $300,000, your capital gain would be $100,000.
Capital gains can be either short-term or long-term, depending on the holding period of the asset. Short-term capital gains taxes apply to assets held for less than a year, while long-term capital gains taxes apply to assets held for longer than a year.
How much is the capital gains tax in Texas? There is no capital gains tax in Texas because there is no income tax — but this does not mean that Texans are exempt from the capital gains tax altogether.
Federal capital gains tax on real estate
As mentioned earlier, while there may not be a capital gains tax in Texas on real estate, realized real estate gains may still be subject to federal capital gains tax. As of the current laws in 2023, the Internal Revenue Service (IRS) imposes the following tax structure on long-term capital gains:
|$41,675 or less
|$41,676 to $459,750
|More than $459,750
|Married (joint filing)
|$83,350 or less
|$83,351 to $517,200
|More than $517,200
|Married (filing separately)
|$41,675 or less
|$41,676 to $258,600
|More than $258,600
|Head of Household
|$55,800 or less
|$55,801 to $488,500
|More than $488,500
Keep in mind that there are exceptions and exemptions to federal capital gains taxes on real estate and that how you will be taxed on gains will differ depending on the type of property you are selling. To calculate the amount of tax owed on a real estate sale, it is best to consult with a financial advisor or CPA who offers high-net-worth tax strategies and can help you minimize your tax liability.
Continue reading: What is the Texas homestead exemption?
How are capital gains calculated on the sale of rental property?
Because a rental property is viewed by the IRS as a business property rather than a primary residence, the capital gains tax calculation is slightly different and will include both federal capital gains tax and depreciation recapture tax. The IRS assesses taxes on the profit generated from the sale of your rental property in two ways:
- Capital gains tax rate of 0%, 15%, or 20% depending on dividends, filing status (single or married), and taxable income
- Depreciation recapture tax rate of 25%
Depreciation recapture is the amount of depreciation deductions taken during the ownership period of a rental property that is subject to the ordinary income tax rate. It essentially “recaptures” those deductions and taxes them at a higher rate. Keep in mind that these laws do not apply to taxing unrealized gains as they only pertain to gains from the sale of a capital asset.
Capital gains taxes in commercial real estate
Commercial real estate is subject to the same federal capital gains tax laws as rental properties including the standard federal capital gains tax, depreciation recapture tax, and any income tax defined by the state (in Texas, there is none). If you sell the property before the one-year mark, you’ll be subject to short-term capital gains tax rates that mirror your typical income rates.
How do I avoid capital gains tax on real estate in Texas?
Wondering how to avoid paying capital gains tax on property? As with any tax, planning ahead can significantly reduce the impact it has on your finances. Some strategies that may help mitigate capital gains taxes include:
- Tax-deferred exchanges (1031 exchanges): This allows investors to exchange one property for another property of “like-kind”, deferring any capital gains tax until the exchanged property is eventually sold. Note that you will eventually have to pay capital gains tax on the sale of the second property unless another 1031 exchange is used.
- Opportunity Zones: Investing in designated “opportunity zones” can allow for the deferral of capital gains taxes on commercial real estate investments until December 31st, 2026 — provided that your money is reinvested into an Opportunity Fund.
- Holding onto your property for longer periods: As mentioned earlier, long-term capital gains tax rates are lower than short-term rates. By holding onto your property for at least one year before selling, you may be able to reduce your tax liability.
- Primary residence exemption: If you have lived in your home for at least two out of the five years before selling, you may be eligible for a primary residence exemption on up to $250,000 (or $500,000 if filing jointly) of capital gains. This means that any profits made from the sale of your primary residence will not be taxed as long as they are within the exemption limits.
- Charitable donations: By donating your property to a charity, you may be able to eliminate capital gains tax on the sale of that property. However, this strategy requires careful planning and coordination with a financial advisor or CPA.
How to avoid capital gains tax on inherited property
How do I avoid capital gains tax on inherited property in Texas? For those who are instead looking to mitigate the impact of capital gains tax on property they were gifted by a loved one, you have the following strategies available to you:
- Sell the property within a year: Since the inherited property is treated as long-term capital gains regardless of how long it was owned by the previous owner, selling the property within one year may allow you to pay lower capital gains tax rates.
- Make it your primary residence: The primary residence exemption may also be an option for inherited property. Living in the inherited property for at least two years before selling it may allow you to avoid capital gains tax on up to $250,000 (or $500,000 if filing jointly) of profit.
- Consider a trust: By placing the inherited property in a trust, you can potentially reduce or eliminate capital gains taxes by spreading out the profits from the sale of the property over a longer period of time.
- Use it as a rental property: Converting the inherited property into a rental property and holding it for at least one year may allow you to take advantage of depreciation deductions and potentially reduce your overall capital gains tax liability. However, this strategy requires careful planning and coordination with a financial planning and tax advisor.
- Disclaim the inherited property: You may choose to disclaim the inherited property and have it passed on to another beneficiary. This can potentially help reduce or eliminate capital gains taxes if the new owner has a lower tax liability than you do.
It is important to keep in mind that tax laws are subject to change and consulting with a financial advisor can help you understand your specific situation and develop a plan to minimize your capital gains tax liability.
Work to optimize your tax planning with the help of Avidian Wealth Solutions
While there may not be a specific Texas capital gains tax on real estate, it is important to understand that you may still be subject to federal capital gains tax and other related taxes upon the sale of your property. However, with proper planning and the help of a skilled wealth advisor from Avidian Wealth Solutions, you can put plans in place that can help minimize your tax liability and maximize your profits on the sale of rental or inherited property.
Whether you inherited property through the greatest wealth transfer in history and are looking to sell or you’re a real estate investor looking to optimize your tax planning, the team at Avidian Wealth Solutions can help. Our high-net-worth wealth management firm offers clients access to a multidisciplinary team of financial professionals that includes tax advisors in Houston, Austin, Sugar Land, and The Woodlands.
Schedule a conversation with us today to learn more about our comprehensive approach to wealth management.
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