COVID has motivated people to move from where they are living to new cities all over the country. During my lifetime, I have never seen such a mass exodus of people moving like this. The exodus has encouraged people to purchase and sell real estate.
When my clients get ready to sell their property the most frequent question I get is, “How much am I going to owe in taxes?” Below I’m going to outline four different ways you can save money when selling your property and give the IRS the least amount of tax legally possible.
Zero Taxes – 2 year test
If you had lived in your home for over 2 out of the last 5 years you may not have to pay any taxes on the gain. That’s right, Congress passed this law to help people when selling their homes. However, there are some rules you need to follow in order to qualify:
- You must have lived in the home for 2 out of the last 5 years
- It only counts for your primary residence (vacation or secondary homes don’t count)
- You can only do use this rule once every 2 years
- If you’re single the first $250,000 of gains are tax free
- If you’re married, the first $500,000 of gains are tax free
Any amount of gain over the limits listed above are taxed as Long Term Capital Gains, which are currently between 15%-23.8%.
Long Term vs Short Term Capital Gains
If you can’t live in the home for 2 years, try and wait at least 1 year before you sell it. Selling your home after owning it for over 1 year, is better than selling it right away. By holding out at least a year, you only pay long term capital gains tax on the gain, which is between 15%-23.8%. If you sell your home before owning it for 1 year you pay the normal tax rates, which can be as high as 37%.
If the property is a real estate investment, such as a rental, office building, raw land, etc., you may defer your taxes through something called a 1031 Exchange. This allows you to kick the can down the road and pay the taxes on a later date. This allows you to trade-up your investment property to a better one and pay no tax now. The 1031 rules are not simple, in fact they are so complicated we wrote an entire article on them. Here is the article that explains more details of what those rules are.
Invest in Opportunity Zones
Opportunity Zones are areas of certain cities that are economically challenged or troubled. In order to have an area deems an Opportunity Zone, they must be as such by certified by U.S. Treasury. Similar to a 1031 exchange, you may take the proceeds from the sale of your property and invest it in Opportunity Zone Fund. The fund will then invest in real estate in an Opportunity Zone. By doing this you may either defer or completely wipe out any taxable gain. Just like a 1031 exchange, investing in Opportunity Zones are complicated. Here are some of the more important rules you will need to know:
- The money must go into a Qualified Opportunity Zone Fund
- The project that the Opportunity Fund invests in must be a Qualified Opportunity Zone
- You must invest the proceeds from the sale of your investment property into the Opportunity Zone Fund within 180 days.
- The new assets you invest in are not taxed until 2026 (or earlier if you exit the project before 2026)
- Based on the number of years you hold the investment, your basis goes up reducing your taxable gain.
- 5 year investments, your basis goes up by 10%
- 7 year investments, your basis goes up by 15%
- 10 year investment, there will be no taxable gain!
Once again, these are very complicated, and we recommend that you talk to a tax professional before investing in Opportunity Zones.