How Much Is Capital Gains Tax on Real Estate Investment Property and How Can You Avoid It?
Running a successful Pittsburgh real estate investment business can be difficult enough as it is; however, the government added an additional obstacle to the mix: the capital gains tax on real estate investment property. Despite the fact that this tax doesn’t actually help the economy, it is in place to prevent investors from gaining a significant income boost from their real estate investment properties.
While the goal of the tax is far more complex, there are many who agree that its scope does not justify the hefty amounts that most investors are required to pay. Fortunately, this is one tax that you can actually escape from.
The Reason Why Capital Gains Tax Is in Place
Capital gains tax on real estate investment property is essentially a tax on capital-based income. Just like any income obtained in exchange for selling products or services will be subject to tax payments, so is the income you gain from your real estate property investments.
In essence, capital gains can be defined as the profits obtained from the sale of a property that is greater than the amount of the sale. Capital gains can result not only from residential and commercial real estate investments, but also from the sale of precious metals like gold and silver, as well as stocks and bonds.
The national legislation in the United States includes many specific and complex requirements relating to capital gains. Practically speaking, capital gains tax on real estate investment property is determined based on a wide array of factors, including whether or not the investment is long term, the tax brackets of each individual investor in part, or the amount of income earned from sources other than real estate – in the case of short term capital gains.
Considering the Value of Capital Gains Tax on Real Estate Investments
Depending on the factors mentioned above, as well as on additional criteria such as the type of real estate you own, capital gains tax on real estate investment property can vary greatly when it comes to the amount you’d have to pay.
The Internal Revenue Service (IRS) employs the tax for real estate investment properties that have remained in the possession of the investor for at least a year. The tax features rates that differ from other types of income, and members of the population belonging to the lowest tax brackets are not required to pay the tax.
Many attempts were made to reduce the capital gains tax on real estate investment property throughout the years. In 1997, the Taxpayer Relief Act brought down tax values based on long term investment from 28% to 20%. Later on, the Jobs and Growth Tax Relief Reconciliation Act of 2003 further diminished the tax from 20% to 15% for individuals who were assigned a 15% maximum tax bracket, and from 10% to 5% for those whose tax bracket was lower than 15%. As of 2006, the Tax Increase Prevention and Reconciliation Act first proposed in 2005 stopped tax payers in the lowest two brackets from paying the tax, and assigned a 15% tax to those in the top 25% bracket and a 20% tax to those belonging to the 39.6% bracket.
Despite these changes, the IRS has never truly waived the tax, and it remains one of the major obstacles that residential and commercial real estate investors are facing today. Moreover, the most recently implemented changes imply that the most successful investors will have to pay the highest capital gains tax on real estate investment property. Fortunately, there are a few ways of permanently counteracting this problem.
Can Capital Gains Tax Be Avoided?
The simple answer is yes. Even though the tax is real, and has to be paid in order to avoid legal issues, the government has left a few loopholes open, allowing investors to refrain from paying it with no legal consequences.
A well-known possible exception when it comes to the capital gains tax on real estate investment property has to do with something called the 1032 exchange. This applies to the sale of rental and investment property, and allows investors to avoid both this tax and the taxes required for depreciation recapture by adding the proceedings to a similar investment after a period of not more than 180 days after the sale.
Also, there is a widely practiced method that realtors and home renovators use when purchasing under-market real estate properties. While investing in the renovation of the property in question, they temporarily turn the new property into their primary residence, then sell it at a higher price while avoiding capital gains tax.
Many other methods exist of avoiding capital gains tax in other investment areas. However, the aforementioned approaches apply specifically to capital gains tax on real estate investment property, and they could actually help you increase your real estate income to a significant extent.