Maintaining rental properties is a great way to earn passive income. Furthermore, many rental property owners choose to sell their properties, usually making a profit in the process. While selling a rental property can earn serious gains, sellers must understand how capital gains taxes will affect their sale. 

Here’s what you should know about capital gains taxes, how these taxes may affect you, and how to reduce them.

What Are Capital Gains?

Capital gains are increases in the value of an asset. This can occur for items sold for a higher amount than the price paid.

There are two categories of capital gains, short-term or long-term:

  1. Short-term capital gains are those that you hold for less than one year before disposal
  2. Long-term capital gains are those that you hold for more than one year before disposal

Whether your capital gains are short-term or long-term, you’ll pay taxes on them when you sell the asset.

How to Calculate Capital Gains

If you need to calculate your capital gains tax, you’ll first determine your tax rate. This rate differs if you have a short-term capital gains tax or a long-term capital gains tax. 

Short-term capital gains tax rates are based on the normal income tax rate. For the 2020 tax year, depending on your filing status, the 10% tax rate ranges from taxable incomes of:

  • Single: $0 to $9,875
  • Married filing jointly: $0 to $19,750
  • Married filing separately: $0 to $9,875
  • Head of household: $0 to $14,100

Depending on your filing status, the 12% tax rate ranges from taxable incomes of:

  • Single: $9,876 to $40,125
  • Married filing jointly: $19,751 to $80,250
  • Married filing separately: $9,876 to $40,125
  • Head of household: $14,101 to $53,700

Depending on your filing status, the 22% tax rate ranges from taxable incomes of:

  • Single: $40,126 to $85,525
  • Married filing jointly: $80,251 to $171,050
  • Married filing separately: $40,126 to $85,525
  • Head of household: $53,701 to $85,500

Depending on your filing status, the 24% tax rate ranges from taxable incomes of:

  • Single: $85,526 to $163,300
  • Married filing jointly: $171,051 to $326,600
  • Married filing separately: $85,526 to $163,300
  • Head of household: $85,501 to $163,300

Depending on your filing status, the 32% tax rate ranges from taxable incomes of:

  • Single: $163,301 to $207,350
  • Married filing jointly: $326,601 to $414,700
  • Married filing separately: $163,301 to $207,350
  • Head of household: $163,301 to $207,350

Depending on your filing status, the 35% tax rate ranges from taxable incomes of:

  • Single: $207,351 to $518,400
  • Married filing jointly: $414,701 to $622,050
  • Married filing separately: $207,351 to $518,400
  • Head of household: $207,351 to $518,400

Depending on your filing status, the 37% tax rate ranges from taxable incomes of:

  • Single: $518,401 or more
  • Married filing jointly: $622,051 or more
  • Married filing separately: $311,026 or more
  • Head of household: $518,401 or more

The long-term capital gains tax rate falls in a range of three categories based on your income: 

  • 0%
  • 15%
  • 20%

The 0% tax rate ranges from taxable incomes of:

  • Single: Up to $40,000
  • Married filing jointly: Up to $80,000
  • Married filing separately: Up to $40,000
  • Head of household: Up to $53,600

The 15% tax rate ranges from taxable incomes of:

  • Single: $40,001 to $441,450
  • Married filing jointly: $80,001 to $496,600
  • Married filing separately: $40,001 to $248,300
  • Head of household: $53,601 to $469,050

The 20% tax rate ranges from taxable incomes of:

  • Single: Over $441,450
  • Married filing jointly: Over $496,600
  • Married filing separately: Over $248,300
  • Head of household: Over $469,050

How to Reduce Capital Gains Taxes

If you have to pay capital gains taxes on the sale of your property, you’ll be pleased to know that there are strategies you can utilize to reduce these taxes. There are at least three ways to reduce your capital gains taxes

You can consider either:

  1. Rental property conversion 
  2. Like-kind property exchange
  3. Tax-loss harvesting 

Rental Property Conversion

First, you may want to reduce your capital gains taxes by converting your rental property to your primary residence. To qualify for this option, you must: 

  • Own your homes for five years; and,
  • Lived in the homes for at least two of those years (the two-year limit isn’t consecutive)

The amount you’ll reduce will depend on how long you used the property as a rental versus your primary residence. 

You can exclude up to $250,000 in capital gains taxes from the sale of your primary residence if you’re single or up to $500,000 if you’re married and jointly filing. 

Like-kind Exchange

Another alternative for you to reduce your capital gains taxes owed is the like-kind property exchange. Section 1031 of the tax code allows you to defer your taxes on the capital game, with some conditions:

  • The deferral of capital gains taxes will occur after selling a rental property. 
  • Then, the seller can purchase a like-kind property. 
  • Tax payments on the property will begin after the exchange is made.

There are also time constraints if you use Section 1031: 

  • You’ll only have 45 days from the sale date of one property to find a replacement property.
  • You’ll need to close on the replacement property within 180 days of the property sale.
  • If you have tax returns due before 180 days, you’ll need to close before the deadline.
  • If you don’t meet the deadline, you’ll pay the full capital gains taxes on the sale of the original rental property.

Tax-loss Harvesting

Finally, you can reduce your capital gains taxes by using tax-loss harvesting. This option allows you to minimize losses as you sell your rental property by combining those losses with gains from another investment. 

There are a few things to know about tax-loss harvesting: 

  • It’s more common with short-term capital gains, but it is also applicable to long-term capital gains. 
  • It’s more common towards the end of the year, but it can happen at any time of the year.

Work with the Pros

If you’re interested in exploring your options regarding capital gains taxes, it’s a good idea to consult a tax professional. They can answer any questions you may have and outline some strategies that could reduce your capital gains taxes. 

Work with the professionals at 1-800Accountant for help with your property and rental income tax needs. 

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Written by Taylor Covey

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