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| 2025 Tax Rates By Income for Long-Term Capital Gains | |||
|---|---|---|---|
| Filing Status | 0% Rate Amount | 15% Rate Amount | 20% Rate Amount |
| Single | $0 to $48,350 | $48,351 to $533,400 | $533,401 and above |
| Head of household | $0 to $64,750 | $64,751 to $566,700 | $566,701 and above |
| Married filing jointly and surviving spouse | $0 to $96,700 | $96,701 to $600,050 | $600,051 and above |
| Married filing separately | $0 to $48,350 | $48,351 to $300,000 | $300,001 and above |
| Trusts and estates | $0 to $3,250 | $3,251 to $15,900 | $15,901 and above |
Source: Internal Revenue Service
Strategies To Minimize Capital Gains Tax
Here are some of the more effective strategies to reduce, defer, or even eliminate your capital gains taxes when selling a rental property:
Don’t Sell Within the First Year
The simplest way to lower your capital gains taxes is to sell your rental property after at least a year of ownership in order to qualify for the long-term rates.
Convert the Rental Property to Your Primary Residence
If you can live in the property for two years before selling it, you could register it as a primary residence and pay less or nothing in capital gains taxes.
Primary residences receive preferential tax treatment. According to Section 121 of the Internal Revenue Code (IRC), profits of up to $250,000 for those who are single and up to $500,000 for those married and filing jointly aren’t taxed.
To qualify for this exemption, you must have owned and lived in the property for at least two of the five years before the sale. (You can’t use this exemption more than once every two years).
“Moving into your investment property could allow you to sell your current primary home right away,” said Scott Westfall, a broker and real estate consultant with Broadside Realty. “After two years, you can then sell your rental property and avoid paying capital gains tax on most, if not all, of the profit from that sale as well.”
Taking Part in Section 1031 Exchanges
If you plan to continue investing in rental properties, a 1031 exchange is worth looking into. Named after Section 1031 of the IRC, it allows investors to postpone paying capital gains tax on rental properties by reinvesting the proceeds in like-kind property.
You’ll need to move fast to qualify for this benefit. After selling the rental property, you have 45 days to choose a new property and six months to complete the transaction. That essentially means you should start looking for a replacement property before selling the old one.
Additionally, bear in mind that the new property must be of equal or greater value and that the funds raised from the old property must be held in escrow by a qualified intermediary until the replacement property is bought.
Sell When Your Income Is Lowest
The rate of capital gains taxes owed depends on your overall taxable income. As such, it makes sense, if possible, to sell rental property in years when you earn less.
If your income fluctuates, consider selling your property in a year when you’re taxes are likely to be lower. Alternatively, if you’re nearing retirement, it could make sense to hold off selling, assuming your retirement income is lower.
Tax-Loss Harvesting
Tax-loss harvesting involves selling investments at a loss to offset capital gains on investments that went up in value.
Here’s an example: Assume you are set to sell your rental property at a $100,000 profit and also happen to have an unrealized loss of $25,000 in an investment you’re keen to exit. If you sell the property and the poorly performing investment in the same tax year, your total taxable capital gain would be $75,000 ($100,000 – $25,000).
There are limits on tax-loss harvesting. If your capital losses exceed your gains in a tax year, not all of those losses can necessarily be applied to your tax bill. If your losses are greater than your capital gains, the maximum you can deduct from your total income is $3,000 per year, or $1,500 if married filing separately. Any unused losses, however, can be carried forward to later tax years.
Deduct Expenses
Another way to reduce capital gains tax liabilities is to deduct as many expenses as possible. The Internal Revenue Service (IRS) permits various deductions on rental property. Qualified expenses, such as mortgage interest payments, maintenance fees, and insurance, can lower your tax bill. You can also use depreciation, which allows you to deduct the rental property’s cost over a set period of time.
When it’s time to sell, you can deduct the costs for offloading your property from your reported capital gain. That includes legal, real estate, and advertising fees as well as expenses to get the property ready for sale.
“You calculate capital gains by subtracting your basis from the sale proceeds of the property,” said Kevin Amolsch, president of Pine Financial Group. “Your basis starts at what you paid for the property when you purchased it. Any depreciation reduces this while improvements increase it.”
Your capital gains tax bill can also be reduced by documenting how improvements and renovations you paid for helped boost the property’s value.
“The higher the basis, the lower the capital gains taxes you’ll need to pay,” Amolsch added. “So be sure to keep track of any improvements made to your properties.”
Professional Advice
You might be tempted to try and save a few dollars by reading articles like this and then forgoing the help of a professional. Doing so could end up costing you more in the long run.
Calculating capital gains on rental property, determining the best ways to lower these liabilities, and then executing these strategies can be complex. For the best results, it’s wise to seek the help of a licensed tax advisor experienced in these sales.
How Much Capital Gains Do You Have to Pay on $400,000?
How much you’ll have to pay in tax on a $400,000 home sale will primarily depend on whether the capital gains are short- or long-term. For example, if a single filer sold their home after owning it for less than a year, they’d be charged a 35% capital gains tax—meaning they’ll owe $140,000. However, if the same filer waited until after that first year, the capital gains tax rate would instead be 15%, so they’d only pay $60,000. Both of these examples assume no other exclusions, discounts, or other options for minimizing capital gains taxes.
Is There a Way Around Paying Capital Gains Tax on Second Property?
Both primary residences and second homes are considered capital assets by the Internal Revenue Service (IRS). However, only the sale of the former is eligible for a capital gains tax exclusion of up to $500,000. Your best chance of avoiding capital gains taxes when selling a second home is to either convert the former into your primary residence or reinvest the profits from the sale to purchase a like-kind property. The former requires living in the second home for a minimum total period of two years (out of the five years prior to the sale).
How to Get 0% Long-Term Capital Gains?
In order to qualify for a long-term capital gains tax rate of 0%, your taxable income cannot exceed the following limits:
- $96,700 for married individuals filing joint returns as well as surviving spouses
- $64,750 for heads of household
- $48,350 for all other individuals
- $3,250 for estates and trusts
The Bottom Line
Holding the property for more than a year, converting it to a primary residence, utilizing section 1031 exchanges, selling when your income is lowest, tax-loss harvesting, and deducting expenses are among the more effective ways to keep more of the profits when offloading rental properties. Capital gains taxes can sting. However, with the help of a lawyer or tax advisor and these strategies, they can be mitigated, delayed, or perhaps avoided altogether.
