These are the ways you can avoid or reduce your capital gains taxes when selling a real estate property.
- Suspended passive losses: This is often overlooked. When you’re selling a rental property there are often suspended passive losses (look for a form 8582 with your tax return), and those suspended passive losses get unlocked when you sell the property (usually, there are some exceptions), and that may partially or fully offset the capital gains. When we run the numbers on it for clients, it’s not unusual to see people end up paying less in taxes if they sell a property than they would have if they didn’t.
- Section 121 exclusion: If the property was your primary home for at least 2 of the previous 5 years before you sold it, you may qualify for the $250,000 ($500,000 if married) exclusion of that portion of the capital gains. If the property was your rental property, and you’re thinking about moving into it for a couple years just to qualify for this exclusion, be aware that your exclusion in that situation would be more limited. If it was a rental first, and you moved into it after, you only get a portion of the capital gains (the formula is the capital gains multiplied by the qualified personal use time divided by the total ownership time). But it still can make sense depending on how the math works out in a particular situation.
- 1031 exchange: You could do a full or partial 1031 exchange, which would fully or partially defer your tax obligations on the gains. Be aware that there are very specific rules about how to perform a 1031 exchange, so if you already sold the property, you generally can’t go back and apply the 1031 exchange treatment after the fact. If you don’t want to continue managing a rental property, it is also possible to exchange into a DST.
- Cost segregation study of another property: If you already own, or are buying, another investment/rental property, but didn’t choose to do a 1031 exchange when buying it, you can use a cost segregation study on that other property to create a tax loss that can offset the capital gains from the sale of this property.
- Installment sale: If you can sell it using seller financing, where the buyer pays you for it over time, this can spread out the capital gains over a number of years and greatly reduce the overall taxes you have to pay on the gains.
- Qualified Opportunity Zone Investment: By reinvesting the capital gains from the sale of a property into a Qualified Opportunity Fund (QOF) within 180 days, the tax on the capital gain can be deferred until the earlier of the sale of the QOF investment or December 31, 2026. If the QOF investment is held for at least five years, 10% of the original deferred gain may be excluded from taxation.
