There are a lot of things to consider when investing in real estate, especially when investing in rental properties. Taxes are a major factor in those considerations, and there’s no applicable tax more severe than the capital gains tax. If you’re not careful, capital gains taxes can cost you a significant portion of your investment and can limit your options when you go to invest in a new property. To help you better understand the basics of capital gains taxes, and what you can do about them, this post will discuss what they are, and how to defer them. Armed with this knowledge, you’ll be prepared to make smarter investing decisions—decisions like the ones that have saved some investors millions.
The capital gains tax is, quite simply, a tax on “capital gains.” In other words, when you sell an investment, the proceeds are considered a “capital gain,” and thus count as a form of taxable income. The problem lies in the fact that capital gains are taxed at a different (and potentially much higher) rate than normal income.
Combined Capital gains can see tax rates as high as 450% including between the capital gains tax, depreciation recapture tax, net investment or Obamacare tax, and state taxes, depending on the state you live in. This severely limits (and reduces) the number of funds mounts your options when you go to reinvest in a new property, and similarly affects the amount of operating income you can expect to receive for a new investment.
The most important thing to remember about capital gain taxes is that you don’t necessarily have to pay them. At least, not yet. You can defer paying on the capital gains tax by availing yourself of the provision in section 1031 of the Internal Revenue Code. Colloquially called a “1031 Exchange,” this involves reinvesting your proceeds into a new property of equal or greater value.
1031 Exchanges are very common and simple to execute. You identify a qualifying replacement property within 45 days of relinquishing the previous property and then reinvest the money in the new property. Then, when the time comes to sell the new property, you do it again. By doing this, you can continue to defer your capital gains tax.
You might be wondering “But I’ll have to pay the tax eventually, right?” The answer, surprisingly, is no. In contrast to the adage, death may be a sure thing, but this tax is not, largely because of the former. If you continue deferring your capital gains tax up until you pass away, you never have to pay it, and the property (whether bequeathed intact or sold upon your death) doesn’t incur the capital gains tax when your posterity inherits it.
You have a variety of options to choose from when identifying a replacement property under a 1031 exchange, though some options are more hands-on than others. A traditional rental or even an NNN (triple net) property will require a certain amount of legwork on your part.
If you’re looking for something truly hands-off, a Delaware Statutory Trust (DST) is probably your best bet. These fractional ownership properties allow you to be part of a high-value property, without having to take overall financial or managerial obligations yourself.
If you’re ready to learn more about how you can defer your capital gains tax and what your options are to do so, contact us here at First Guardian Group. We have extensive experience handling 1031 Exchanges, and we can help you with every step of the process, from answering questions to assisting you in finding a new investment. We even have a selection of DST properties you may be interested in investing in.
It’s time to leave the stress of capital gain taxes behind, and let your whole investment continue working for you. You can do this, and First Guardian Group can help.