"Overview of Capital Gains Tax on Investment Property"
for a profit, you will incur a capital gains tax, which could very well be one of your largest
Just like with stocks, commodities, businesses, or any other investment vehicle, any and all capital gains on investment property sales are taxable.
On the flip side, selling for a loss would act as one of your
but as long as you have a
long term investment horizon,
the chances you'll experience a loss when you sell are slim to none.
Disclaimer: Please note that I am no tax expert. There are many adjustments, rules, exceptions and special cases in the code pertaining to capital gains taxes, so please make sure you leverage the expertise of your accountant.
SHORT VS. LONG TERM CAPITAL GAINS TAX
Assuming you are holding your
multi family properties
in a single-member
real estate LLC,
your capital gains liability will depend on how long you owned each property that you sell.
The tax rate will be lower on "long-term capital gains," which are gains on assets that you hold for at least 1 year. This rate is currently 15% (5% for low income folks). The 15% rate is set to "expire" in 2010 and is expected to increase to 20% or more soon thereafter (boo!).
Short-term capital gains on investment property sales are taxed at a much higher rate called the "ordinary rate." The specific short-term capital gains tax rate depends on your personal tax bracket and could be as high as 35%.
CALCULATING YOUR CAPITAL GAINS TAX
Here are the steps to determine your capital gains tax:
- Determine your adjusted basis
- Subtract your adjusted basis from your sell price (gross profit)
- Multiply gross profit by the appropriate capital gains tax rate (either 15% or the ordinary rate)
You must first determine the taxable amount (i.e., the amount of your gain). The taxable amount is the difference between your sell price and your adjusted basis.
Your original basis is the amount you paid when you
the property. From this, you will have to figure out your adjusted basis, which is the result of increasing or decreasing your original basis by doing certain things.
The following are items that increase your basis (add these costs to your original purchase price):
- The cost of improvements having a useful life of more than a year
- Assessments for local improvements
- Sales tax that is not deducted
- The cost of extending utility lines to the property
fees such as the cost of defending title
- Zoning costs
The following are items that will decrease your basis (subtract these costs from your original purchase price):
- Property depreciation
- Nontaxable corporate distributions
- Insurance reimbursements for casualty and theft losses
- Rebates from the manufacturer or seller
Of course, you'll want to increase your basis as much as legally possible in order to minimize your capital gains tax investment property expense.
OPTIONS TO DEFER CAPITAL GAINS TAX
The IRS allows you to defer capital gains taxes with certain tax planning strategies. I don't really worry about these things too much and so this topic is beyond the scope of this site.
But if you wanted to do your own independent research, here are the deferment strategies to investigate:
- 1031 exchange
- Structured sale
- Charitable trust (CRT)
- Private annuity trust
Of course no one wants to be taxed for capital gains on investment property sales, but hey, it's better than selling for a loss!
The bottom line is that absent of flat out deferment, you'll want to minimize your capital gains tax investment property liability by holding each property for more than 1 year and maximizing your adjusted basis.
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