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I Need to Sell My Rental Property: But I'm Afraid of the Taxes!
Dated: February 10 2021
If You're Concerned About Paying Taxes When You Sell Your Rental, Don't Be!
Taxes are always a huge concern for landlords when it comes time to make the decision to sell or keep renting. I have seen so many people choose to keep a property they should have sold because the thought of dealing with the tax implications was just too much for them to handle. Clearly, the lady above fell into that category.
I am not a tax professional and you should absolutely consult your CPA or tax professional to confirm anything I say here. However, I have sold hundreds of properties, many of which were my own, and have leveraged the benefits built into the tax code with relative ease. In my experience, there are three key takeaways of selling an investment property in the context of taxes.
1. Principal Home Tax Exclusion: If you lived in the home for two out of the five years prior to selling your investment property as a primary residence, any gains up to $250,000 for a single person or up to $500,000 for a married couple is considered tax free. It's an incentive to get more people to buy homes. So, if you moved two years ago and have been renting out the house since then, you would qualify. Here's more on it from the IRS site: Principal Residence Exemption
2. Leverage a 1031 exchange: The IRS Code 1031 is an excellent tool the government provides us investors to sell a property without paying capital gains tax. There are a lot of nuances to a 1031 exchange which we can talk about in depth if you like, just let me know and we can chat. But, to delve deeply into it is an entirely different blog post. I have done several 1031 exchanges on my own properties and for others and they are quite easy. The key here is you are selling your property with the intent of rolling those funds into another like-kind investment (real estate, in this context) that costs at least as much as what you sold your home for. So, one example in my own life was my first investment property. I sold a rental condo in Reston, VA with a 1031 exchange. Those funds were put into escrow and a couple months later I closed on two single family homes in NC using the funds from the Reston sale as down payments on the two houses, and I deferred those capital gains taxes indefinitely.
3. Pay Capital Gains Taxes: I'll qualify this by adding that you should only pay your fair share of capital gains taxes, and you do so by keeping good records and working with your tax advisor. You might discover that even though you bought your house for X and then sold it for a lot more, Y, you also spent a lot on renovating and maintaining the property, Z, which would be reduced from the difference between X and Y. Then, you would calculate your capital gains tax payment off the reduced amount, and capital gains rates are lower than regular tax rates and are based on your income. Here's a link to a worksheet you can use to calculate your potential capital gains. I hope it is of value to you!
Landlords, do not be afraid to sell your home for fear of paying taxes. There are ways to NOT pay taxes that are quite common and the government wants you to use them! Furthermore, if you do end up in a position where you will need to pay taxes on your capital gains, 9 out of 10 times you're going to realize it is nowhere near as high a number you will owe Uncle Sam as you thought. Take it from me, I've been there and done that time and time again. You're going to be fine!
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