What are capital gains taxes?
When you buy a property and then sell it for more, you’ve realized a financial gain. That’s income, and it’s taxable as part of your income tax. Selling any kind of asset can trigger capital gains tax, but it often relates to real estate.
Short-Term gains can be expensive.
If you’ve owned the property for less than a year, your gain will be taxed as regular income. That’s the same tax rate you pay on your salary and wages. High earners, those in the higher tax brackets, can face a very large tax bill. For this reason, house flippers generally pay higher taxes than other types of investors.
Long-Term gains are taxed at a lower rate.
Selling a property after one year greatly reduces the capital gains tax rate. In 2016, the capital gains rate was 0-20% depending on your income tax bracket. For this reason, it usually pays to hold real estate at least one year before selling.
There are ways to avoid it.
Many people never pay capital gains on their real estate sales. This can be done legally through an exemption or deferral. The key ways to avoid capital gains are:
The primary residence exemption: if you’ve lived in the home for at least 2 of the past 5 years, you can exempt capital gains up to $250,000 for a single person or $500,000 for a married couple filing jointly.
1031 exchange: if you’re selling an investment property to buy another one, there is a special procedure to legally defer capital gains.
Death: if you pass property when you die, your heirs enjoy a “stepped up basis,” effectively waiving the capital gains during your lifetime.