What Is Capital Gains Tax for Real Estate Investments?

Individuals who invest in real estate opportunities may need to consider how capital gains taxes impact the expenses and profits associated with those investments. Whether you’re looking to become the landlord of a single home or duplex, want to get into the house-flipping niche, or think becoming an Airbnb host/hostess is a great way to supplement your income, learning about capital gains tax is important. What is capital gains tax? Find out more below to help protect your future investments.

What Is Capital Gains Tax?

Capital gains tax is a tax you may need to pay on the profits of certain investments when you sell the investment property. Capital gains taxes can be applied to a variety of properties and investments, including stocks and certain types of real estate.

Federal vs. State Capital Gains Taxes

You may pay capital gains taxes on profits from investment sales at both the state and federal levels. Most states treat capital gains as a form of income, taxing it at the same rate it would tax income from work.

Some states provide tax breaks for capital gains in various forms. For example, Arizona, Arkansas, Hawaii, Montana, New Mexico, North Dakota, South Carolina, Vermont, and Wisconsin all tax capital gains income at rates lower than their tax work income, according to the Center on Budget and Policy Priorities. The CBPP also notes that some states, including Louisiana, Oklahoma, Idaho, and Colorado, provide capital gains tax breaks for those that invest in businesses within the state and some states favor investments in certain industries with capital gains tax breaks.

Short-Term vs. Long-Term Federal Capital Gains

How you’re taxed on your investment profits depends in part on how long you held the asset. If you held the asset less than a year before selling it, any profits are considered short-term gains. If you held the asset for more than a year, typically those profits would be considered long-term gains.

Short-term gains may be taxed at a rate between 10 and 37% for 2020 earnings, for example. The taxable amount depends on how much income you earned in the year and what type of filer you are (single, married filing jointly, etc.)

Long-term gains are taxed at between 0 and 20% depending on income and type of filer you are. For example, for the 2020 tax year, single filers with a taxable income between $40,001 and $441,450 would pay 15% on capital gains. In most cases, you save on taxes by holding an investment for a year or longer due to the different ways they’re taxed.

However, there is an exception to this rule. Profits from the sales of collectible items, including coins, fine art, antiques, and some wine, are taxed at 28% no matter how long you’ve held them.

What Are Capital Losses?

You don’t always earn a profit when selling an investment property. If your property decreases in value and you sell it for less than you purchased it for, you may be able to report a capital loss.

You can use capital losses to offset capital gains so you don’t have to pay taxes on them. For example, imagine that you own two real estate investment properties. You sell one for a profit of $25,000. In the same year, you sell the other at a loss of $15,000. The $15,000 loss offsets part of your capital gains, so you might only need to pay taxes on $10,000 in total gains.

If your losses are more than your gains, you may be able to reduce your taxable income. You can claim up to $3,000 in many cases of capital losses as a deduction to lower your income.

If your total losses are more than $3,000, you may be able to carry over those losses to offset capital gains next year. This can be a helpful tax tactic for people who flip one or two houses a year; your losses in one year could help you reduce your tax burden if you have profits in the next.

How Do You Report Capital Gains and Losses?

Capital gains and losses have to be reported to the federal government when you file your income tax return. If you’re an individual who owns rental properties or real estate investments and you sold any during the previous tax year, you may need to complete Schedule D for Form 1040. You might also need to complete form 8949 to report the sales of your capital assets.

Let’s be honest, though. Flipping between tax rate charts, the forms, and your own business or financial books seems like a lot of work, and there are plenty of places to make mistakes when you’re filling these forms out manually.

If you’ve set up a business for your real estate investment opportunities, you may want to get an accountant for that business. A CPA with tax experience, especially with regard to real estate investments, can help you maximize your deductions, manage your capital gains and losses appropriately, and ensure you’re saving on your tax bill where possible without running afoul of compliance.

The same is true if you haven’t set up a business and are just investing in property in your own name. If you’re business and tax-savvy and don’t want to pay a CPA, you might consider using a high-quality tax preparation software that’s programmed to take real estate investments into account. These programs tend to have wizards that walk you through entering all the necessary information before conducting the calculations for you.

Do You Pay Capital Gains Tax on the Sale of Your Own Home?

If you’re selling your home to buy a new one or because you’re ready to spend a year on the road in a family RV, you probably won’t have to pay capital gains taxes. Homeowners can exclude up to $250,000 in profits (or $500,000 for married couples) on the sale of their primary residence.

To get this exclusion, you must have lived primarily at this property for at least two out of the past five years.

Being Prepared for Taxes Is Important When Investing in Real Estate

Whether you’re poised to buy your first Airbnb property or you’re considering converting your home into a rental property when you buy a new place to live, being prepared is important. That includes factoring in all the expenses that can come with real estate investments — maintenance and repairs, insurance, marketing, and vetting tenants, and listing fees when you’re ready to sell are just some expenses to consider. Taxes, including capital gains taxes, are another.

How Can LemonBrew Help?

Being prepared financially doesn’t just apply to expenses and taxes. If you’re looking to invest in real estate — or simply purchase your next residence — you might need a mortgage. Connect with an experience mortgage advisor today to find out more about your options for getting a mortgage or refinancing a property you already own to reduce your real estate investment expenses.