Offset Gains With Losses
- What it is: Tax-loss harvesting
- Who its for:Anyone with capital losses in a given tax year
- What you get:The ability to subtract those losses from the capital gains realized from a rental property sale
Tax-loss harvesting describes the process of reducing tax exposure when selling a rental property by pairing the gains from the sale with the loss from another investment. This can be a tax planning strategy if an investor is holding an investment that has lost value and decides to sell the asset at a loss in the same year as the gain on rental property sale . Although this tax-minimizing tactic primarily serves to offset gains from stock investments, more folks are now applying it to rental real estate property sales.
For example, assume an investor made $50,000 from the sale of a rental apartment in the current year. They also have an unrealized loss of $75,000 in the stock market. The investor can choose to sell off a portion of their stocks to realize a $50,000 loss in order to fully offset the $50,000 in capital gains.
Selling Your Rental Property
If you sell a rental property for more than it cost, you may have a capital gain.
List the dispositions of all your rental properties on Schedule 3, Capital Gains . For more information on how to calculate your taxable capital gain, see Guide T4037, Capital Gains.
If you are a partner in a partnership that has a capital gain, the partnership will allocate part of that gain to you. The gain will show on the partnership’s financial statements or in box 151 of your Slip T5013, Statement of Partnership Income. Report the gain at line 17400Footnote 1 of Schedule 3.
A Financial Advisor Can Help You Navigate Capital Gains Tax Complexities With Success
Huge capital gains tax bills can be a frustrating part of a real estate transaction of an investment property, but with a little creative thinking, they can be deferred and even avoided if certain conditions are met. Tax planning can be tricky, and having an experienced financial advisor help you navigate the ins and outs of maximizing your income from financial transactions can be hugely beneficial. For more information on how we can help you please visit us at our website, or schedule a free consultation.
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What Is Capital Gains Taxand Who Pays It
In a nutshell, capital gains tax is a tax levied on possessions and propertyincluding your homethat you sell for a profit.
If you sell it in one year or less, you have a short-term capital gain.
If you sell the home after you hold it for longer than one year, you have a long-term capital gain. Unlike short-term gains, long-term gains are subject to preferential capital gains tax rates.
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Capital Gains Inclusion Rate
Thecapital gains inclusion rateof 50% determines how much of your total capital gains that will be subject to tax. Investments in registered plans such as aRegistered Retirement Savings Plan , Registered Retirement Plan , or Tax-Free Savings Account are considered tax-sheltered and capital gains tax will not be charged on investments while they are held in these accounts. The disadvantage with a registered investment account is that you will also not be able to carry forward any capital losses. For more information on registered and non registered investment accounts, seeCapital Gains on Investment Accounts.
How To Calculate Capital Gains Tax
Weve explored how capital gains tax on real estate works, lets dive into how capital gains tax is calculated. If youre unfamiliar with capital gains, here are some basics you should know.
Capital gains are simply the profit you make when selling an asset, such as stocks, real estate, and other investments. The formula for calculating capital gains tax for real estate will work similarly for any other asset, with slight intricacies that will be covered later. The formula for capital gains tax is:
Capital Gains = Selling Price Original Purchase Price
The IRS taxes investors on these capital gains, thus the name capital gains tax. Any time you make income from employment, the government will take a cut. Any income earned from selling assets is no different.
You may wonder if you will owe any taxes if an asset you own, whether real estate or stocks, increases in value. The answer is no. You will only owe capital gains tax when your gains are realized, which means youve sold the asset and pocketed the cash. When youre still in possession of the asset, its known as an unrealized gain regardless of the duration.
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I Plan To Sell Soon Anyway
A few more months of passive income is beneficial, but if youve been thinking about selling in the near future anyway, it can be smart to sell when you know you can fetch a high sale price. After all, if you wait and have to sell at a lower price down the road, those monthly rent checks may not have been worth it.
Improving Cash Flow Potential With A 1031 Exchange*
In addition to tax savings, a 1031 Exchange can improve the potential for cash-flow and appreciation by allowing the proceeds to be reinvested. In our example, the investors total tax liability would be $1,131,950. If the post-tax proceeds of $2,118,050 were reinvested and earning a 5% return, this would generate $105,903 in annual income. However, by performing a 1031 Exchange, the investor would have $3,250,000 to reinvest. At the same return of 5%, the exchange proceeds would generate annual cash flow of $162,500. The difference in cash flow potential of over $56,500 represents one of the primary benefits of 1031 Exchanges the ability to keep all your equity working for you to generate income and appreciation.
* Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.
- Speak with a licensed 1031 Exchange Advisor
- Discuss your potential tax liability
- Understand benefits vs. risks
Austin Bowlin, CPA is a Partner at Real Estate Transition Solutions. As a licensed 1031 Exchange Advisor, Austin helps investment property owners navigate and execute 1031 Exchanges and Delaware Statutory Trusts investments. To schedule a free consultation call .
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What Records Do You Have To Keep
You will need information from your records or vouchers to calculate your capital gains or capital losses for the year. You do not need to include these documents with your income tax and benefit return as proof of any sale or purchase of capital property. However, it is important that you keep these documents in case the CRA asks to see them later.
If you own qualified farm or fishing property or qualified small business corporation shares, you should also keep a record of your investment income and expenses in case you decide to claim a capital gains deduction in the year of sale. You will need these amounts to calculate the cumulative net investment loss component of the capital gains deduction. You can useForm T936, Calculation of Cumulative Net Investment Loss to December 31, 2020, for this purpose.
In addition, you should keep a record of the fair market value of the property on the date you:
- inherit it
- receive it as a gift
- change its use
First Make Sure You Actually Have A Tax Loss
You might be looking at loss if you have to sell a rental home in a down market or have just had to put more money into a property than it is worth. To determine if you have a tax gain or loss, you will need to compare the propertys sale price to its tax basis. The tax basis is generally your original purchase price, plus the cost of improvements , minus any depreciation deductions you claimed while you owned it.
Be careful if you acquired the property in a tax-deferred Section 1031 like-kind exchangewhere you swapped another property for the one youre thinking about selling. With a 1031 exchange, you defer paying the tax on a gain from selling one property by exchanging it for another property. To avoid recognizing the gain on the sale of your first property, you can transfer your cost basis to the new property. This can result in a small amount of tax basis in the property that you are trying to sell. The propertys basis may be lower than you think.
Bottom Line: Make sure you know your propertys tax basis before you sell. That way you wont be expecting a loss and instead wind up with a gain that increases your tax bill.
TurboTax can help you track your tax basis for your properties.
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Capital Gains Tax In Canada: Buying Or Selling An Investment Property
Are you planning on selling your second home or income property? When selling an investment property, paying taxes is inevitable. In Canada, anyone who sells a capital asset should know what a capital gain is. To help you out, we provided a brief summary below of what capital gains are, along with a few tips on how you can reduce the amount of CRA capital gains taxes you need to pay.
What is a capital gain or capital loss?
A capital gain is an increase in an investment, such as real estate holdings. When you sell a capital property for more than you paid, you have a capital gain. You must include this gain on your annual income tax return and are taxed a percentage of that gain.
A capital gain is either realized or unrealized. When you sell real estate for more than you purchased for it, your capital gain is realized. An unrealized capital gain is when your investment increases in value, but you have not sold it, and therefore is not considered a taxable capital gain.
A capital loss is incurred when there is a decrease in the capital asset value. A capital loss occurs when the value of your real estate holdings decreases to less than the original purchase price.
How are capital gains taxed in Canada?
How do you calculate a capital gain or loss on a recently sold property?
According to the CRA, to calculate your capital gain or loss, you need to know the following amounts:
How can you keep more capital gains when selling a property in Canada.
Deferring Capital Gains Tax With A 1031 Exchange
Real estate investors have the opportunity to defer, reduce, and even eliminate paying capital gains taxes by performing a 1031 Exchange, also known as a like-kind exchange. A 1031 Exchange, named for Section 1031 of the U.S. Internal Revenue Code, is a transaction approved by the IRS, which allows real estate investors to defer the tax liability on the sale of investment property. To defer the capital gains tax on the proceeds of investment property, investors must reinvest their sales proceeds into like-kind investment property of equal or greater value. Like-kind is defined by the IRS as any real estate of the same nature or class, not of the same quality or property type. Generally, this means that you can exchange any investment real estate assetnot a personal residencefor another investment real estate asset. For more information on 1031 Exchanges, download our free guide, Understanding 1031 Exchanges by visiting www.re-transition.com/sfaa.
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Your Annual Tax Return
Each year that you own a rental property, you will need to complete an IRS Schedule E form to report your income and expenses. Youll report all income received from the property that year, then reduce your income by the amount of your expenses, including mortgage interest, insurance, taxes and property management. You will also depreciate the value of your investment using Form 4562.
The income, expenses and depreciation reported on Schedule E may increase or decrease your overall taxes each year. However, it is important to remember that the depreciation will impact your taxes when you sell. Read IRS Publication 527.
How Much Will I Have To Pay
Most taxpayers miscalculate their capital gains by simply subtracting the purchase price from the selling price. But under the tax code, purchase price and selling price are much more.
Your purchase price or cost basis is what you paid for the house or property plus all the taxes and fees you paid when you bought it, typically from 2% to 5% of the cost. You can also include money spent on projects that added value to the property, like that extra bathroom or garage improvements.
On the other end of your investment, your selling price is what you sell your property for minus any commission or closing fees you pay to sell it.
Lets say that years ago you paid $200,000 for a house. At that time, you paid $8,000 in taxes and closing fees. Since then, youve made $30,000 in improvements. In this case, your cost basis is $238,000.
|Original purchase price|
Your taxable profit on your recent sale is $212,000. And because you bought the home more than two years ago, you can walk away with your $212,000 tax-free.
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Keep Records Of Home Improvement And Selling Expenses
If youre selling your primary residence, dont forget to track all the expenses associated with renovating and selling the home.
Additions or home improvements made to the property over the years can also add to your basis in the property, which translates into lower capital gains when you sell.
In addition, you can deduct the expenses associated with the sale of the property to reduce the amount of CGT you have to pay.
This strategy works well for a primary residence. However, real estate investors with multiple properties should check with their tax advisors to see if theyre eligible.
Avoiding Capital Gains Tax On A Rental Or Additional Property
If you own an additional property that you plan to sell, you will need to plan ahead to lower your tax liability. Three ways to avoid the tax liability include:
Establishing the rental as primary residence
You might find that an investment property you rent and plan to sell has spiked in value. It may be a good idea to move into the rental for at least two years to convert it into a primary residence to avoid capital gains. However, you wont be able to exclude the portion you depreciated while renting the property.
Youll lose primary residency status on your main home, but it can always be gained later by moving back in after the sale of the rental property. As long as you dont plan to sell the main home for at least two years, you can re-establish primary residency and qualify for the capital gains exclusion later.
You can also take advantage of a 1031 exchange. Known as a like-kind exchange, it only works if you sell the investment property and use the proceeds to buy another, similar property. Youre basically putting off capital gains tax indefinitely as long as you keep putting the sale of the proceeds into another investment property, you can avoid capital gains taxes.
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What Is Capital Gains Tax On Real Estate
The name says it all: capital gains tax on real estate simply refers to the tax levied on any gains made from a real estate sale. To clarify, capital gains are only realized when an asset is sold for more than it is purchased. Therefore, you may not be taxed on capital gains if you sell a property for less than you bought it for.
Generally, its rare to sell an asset for more than it was purchased for due to depreciation, but if an individual does sell their asset for more than they acquired it, the asset would then be classified as a capital gain. Capital gain can be applied for more than just real estate gains. It can also apply to a car, boat, or even rare piece of artwork that is sold for more than it was initially purchased.
Invest In Opportunity Zone Funds
In 2017, the U.S. government designated many distressed areas as Opportunity Zones in an effort to drive investment in housing, small businesses, and infrastructure in those regions.
When you invest in Opportunity Zones with the capital gains from the sale of a property, you can take advantage of the following tax benefits:
- Defer all capital gains for eight years if the profits are reinvested and held in an Opportunity Zone.
- Receive a full exemption from any capital gains tax on all future capital gains from the invested funds if the investment is held for at least 10 years.
If you want to stick with real estate when reinvesting your capital gains, look for Opportunity Zone Funds that buy older buildings in Opportunity Zones, renovate them at a reinvestment cost, then manage them as rental properties just like we do here at Lifeafar.
This strategy is great for real estate investors who buy and sell multiple properties and generate revenues that put them in high tax brackets.
Theres no restriction on your current income level, the amount you can invest, or your state of residence. You dont have to wriggle yourself into any tax bracket or wrangle with endless legal paperwork.
Investing in a Opportunity Zone Fund is by far the most straightforward, versatile, and profitable way to reduce your capital gains tax when you sell your property. And our team at Lifeafar can guide you through the investment process.
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