How can you avoid paying capital gains tax by buying another house

How can you avoid paying capital gains tax by buying another house?

A property sale creates a taxable event. Capital gains tax will apply if you made a profit from the sale of your property. However, there may be exceptions.

Several options are available to reduce or eliminate capital gains tax when you buy another house. This depends on whether you intend to use the funds for personal purposes or reinvest them in an investment property through a similar exchange. These guidelines will help you determine when capital gains tax is due and whether you are eligible for an exemption.

What is Capital Gains Tax ?

Capital gain refers to the amount of profit an asset earned over its holding period. A capital gain can be tangible property like real property, personal property, or intangible property like shares or intellectual property. The tax rate on long-term capital gains is lower if the investment is kept for longer than one year. If the capital gains are not held for more than one year, they are treated as ordinary income.

These assets become taxable events when they are “realized” or sold. The IRS will tax your gain from the sale of an asset. If you are eligible, exclusions apply to homes.

Capital Gains Exemptions Tax for Primary Residence

Capital gains tax applies to your home, which is considered a capital asset. Capital gains tax may apply to your home if it appreciates at a price. You may be exempted by the Taxpayer Relief Act (1997)

Here are the steps to qualify for capital gains exemption on your primary residence.

  • The home has been yours for at least two years
  • At least two years have you lived in your home
  • The gains from homes sold in the past two years are not exempted

These requirements will determine how much you can exclude if you meet them. The amount you can exclude for a single filer is $250,000, and the amount for joint filers is $500,000.

For example, a married couple buys a house for $100,000 and lives there for ten years. Their gain from selling their house was $75,000, which is $175,000 compared to their loss of $75,000. Capital gains tax would not apply to them as they have met all requirements and their gain was less than $500,000. They can use the income as they wish.

The 1031 Exchange

But what if it isn’t your primary residence? What if you are renting the property to generate passive income? You can defer capital gains tax liability if you structure your transaction in a 1031 exchange and an investment property.

You must follow these rules to be eligible for a 1031 exchange. Here is a general qualification checklist:

  • An investment property is yours.
  • You want to exchange or sell your investment property for another property of the same type.
  • Specific rules and requirements must be followed.

Find out if you are eligible for a 1031 exchange that defers capital gains tax. Make sure you plan and ensure your exchange adheres to IRS guidelines. You might have to pay a substantial capital gains tax if your exchange is not eligible.