How to Lower Capital Gains Taxes on Rental Properties

February 3, 2022
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Rental properties are a convenient way to increase assets. Capital gains tax may play a significant role in rental property landlords’ investments.

The exact amount you may owe in capital gains tax can depend on different criteria, but there are ways you can avoid paying capital gains tax. Here is what you should know about lowering capital gains tax on rental properties.

What Are Capital Gains Taxes?

Capital gains taxes are taxes owed after the sale of an asset. Depending on how long you’ve held onto the investment property, you’ll pay tax on the asset. There are two capital gains taxes: long-term capital gains taxes and short-term capital gains taxes. 

Long-term capital gains taxes apply to assets you’ve held for more than one year. These taxes have three tax rates which will determine the amount you’ll owe. 

Short-term capital gains taxes apply to assets you’ve held for one year or less. In contrast to long-term capital gains, profits from short-term capital gains are taxed as ordinary income.

How Do Capital Gains on Investment Properties Work?

Capital gains for investment properties work like other assets. A capital gain occurs when you sell an asset for more than you paid. Capital gains are realized when you subtract the purchase price from the sale price.

You’ll pay for long-term capital gains and short-term capital gains using tax return forms.

3 Strategies to Reduce or Lower Capital Gains on Rental Properties

You can use three strategies to lower or reduce capital gains tax on rental properties: 1031 exchanges, offsetting losses with gains, and rental property conversion.

1. 1031 Exchanges

The first strategy you can use to lower capital gains tax involves 1031 exchanges. You can use section 1031 to sell a rental property while purchasing a like-kind property. 

Like-kind properties are properties of the same character or nature, even if their grade or quality differs. 

If you defer paying capital gains taxes using 1031 exchanges, you’ll have to remember three deadlines:

  • You’ll have 45 days from the property sale date to find potential replacement properties.
  • You’ll have up to 180 days to close on the replacement property.
  • If a tax return is due (with extensions) before the 180 days, you’ll need to close sooner. 

2. Offset Losses with Gains

Another way you can lower capital gains tax is to offset losses with gains. This option allows you to subtract losses from realized capital gains from a rental property sale. 

You may consider this option if you’ve had capital losses in a tax year.

3. Convert Your Rental to a Primary Residence

The third strategy you can use to lower capital gains tax is converting your rental into a primary residence.

By converting your rental into a primary residence, single taxpayers can exclude up to $250,000 from the sale of the property. Married taxpayers can exclude up to $500,000 if they’re married and filing jointly.

There are two things to know about qualifying for rental conversion into a primary residence. First, you must have lived in their primary residence for two out of five years before the sale. Second, the years you must live in your primary residence don’t have to be consecutive.

How Is Capital Gains Tax Calculated On Rental Property Sales?

You’ll calculate capital gains tax on rental property sales based on filing status, tax rates, and time you’ve possessed the rental property. 

Long-term capital gains experience taxation according to three tax rates:

  • 0%
  • 15%
  • 20%

For the 2021 tax year, you’ll have a long-term capital gains tax rate of 0% on taxable income up to:

  • $40,400 if you’re single.
  • $80,800 if you’re married, filing jointly.
  • $40,400 if you’re married, filing separately.
  • $54,100 if you’re the head of household.

You’ll have a long-term capital gains tax rate of 15% on taxable income between:

  • $40,400 to $445,850 if you’re single.
  • $80,800 to $501,600 if you’re married, filing jointly.
  • $40,400 to $250,800 if you’re married, filing separately.
  • $54,100 to $473,750 if you’re the head of household.

You’ll have a long-term capital gains tax rate of 20% on taxable income over:

  • $445,850 if you’re single.
  • $501,600 if you’re married, filing jointly.
  • $250,800 if you’re married, filing separately.
  • $473,750 if you’re the head of household.

According to your filing status and federal income tax bracket, short-term capital gain tax rates differ. For the 2021 tax year, you’ll pay capital gains taxes at a 10% tax rate if your taxable income ranges from:

  • $0 to $9,950, and you’re single.
  • $0 to $19,900, and you’re married, filing jointly.
  • $0 to $9,950, and you’re married, filing separately.
  • $0 to $14,200, and you’re the head of household.

You’ll pay capital gains taxes at a 12% tax rate if your taxable income ranges from:

  • $9,950 to $40,525, and you’re single.
  • $19,900 to $81,050, and you’re married, filing jointly.
  • $9,950 to $40,525, and you’re married, filing separately.
  • $14,200 to $54,200, and you’re the head of household.

You’ll pay capital gains taxes at a 22% tax rate if your taxable income ranges from:

  • $40,525 to $86,375, and you’re single.
  • $81,050 to $172,750, and you’re married, filing jointly.
  • $40,525 to $86,375, and you’re married, filing separately.
  • $54,200 to $86,350, and you’re the head of household.

You’ll pay capital gains taxes at a 24% tax rate if your taxable income ranges from:

  • $86,375 to $164,925, and you’re single.
  • $172,750 to $329,850, and you’re married, filing jointly.
  • $86,375 to $164,925, and you’re married, filing separately.
  • $86,350 to $164,900, and you’re the head of household.

You’ll pay capital gains taxes at a 32% tax rate if your taxable income ranges from:

  • $164,925 to $209,425, and you’re single.
  • $329,850 to $418,850, and you’re married, filing jointly.
  • $164,925 to $209,425, and you’re married, filing separately.
  • $164,900 to $209,400, and you’re the head of household.

You’ll pay capital gains taxes at a 35% tax rate if your taxable income ranges from:

  • $209,425 to $523,600, and you’re single.
  • $418,850 to $628,300, and you’re married, filing jointly.
  • $209,425 to $314,150, and you’re married, filing separately.
  • $209,400 to $523,600, and you’re the head of household.

You’ll pay capital gains taxes at a 37% tax rate if your taxable income ranges from:

  • $523,600 or more, and you’re single.
  • $628,300 or more, and you’re married, filing jointly.
  • $314,150 or more, and you’re married, filing separately.
  • $523,600 or more, and you’re the head of household.

Lower Your Tax Bill with 1-800Accountant On Your Side

Capital gains tax can vary because of a lot of factors. Whether your capital gain is long-term or short-term, you’ll want to pay the tax bill when tax season arrives.

When it’s time to lower capital gains tax, make sure you work with accountants who can help you. Work with the professionals at 1-800Accountant to reduce your tax bill.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.