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HOW TO REDUCE CAPITAL GAINS TAX
Educational guide to legal strategies investors generally use to reduce or defer capital gains tax
Category: Guides
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Investors selling appreciated real estate in the Las Vegas area generally have several legitimate strategies available to reduce or defer the resulting capital gains tax. This is a general educational overview of the more common approaches. It is not tax, legal, or investment advice, and any specific strategy should be evaluated with a tax advisor before a sale.
Deferring Gain With a 1031 Exchange
A 1031 exchange generally allows an investor to defer federal capital gains and depreciation recapture tax by reinvesting the proceeds from a sold investment property into a qualifying replacement property within the applicable identification and closing deadlines. This is generally one of the most widely used deferral tools available to real estate investors, though it generally requires working with a qualified intermediary and generally applies only to property held for investment or business use.
Considering an Installment Sale
An installment sale generally allows a seller to spread the recognition of gain over the years in which payments are actually received, rather than recognizing the entire gain in the year of sale. This generally can help manage which tax bracket the gain falls into each year, though it generally does not reduce the total tax owed over time and generally introduces counterparty risk that should be weighed carefully.
Using the Section 121 Exclusion Where Applicable
For a primary residence, the Section 121 exclusion generally allows up to two hundred fifty thousand dollars, or five hundred thousand dollars for a married couple filing jointly, of gain to be excluded from tax entirely, as long as the ownership and use tests are generally met. This exclusion generally does not apply to investment property, but a former primary residence converted to a rental may in some cases generally support a combined strategy, which should generally be confirmed with a tax advisor.
Timing Gains Around Income and Rate Brackets
Because federal long term capital gains rates generally step up at certain income thresholds, some investors generally work with a tax advisor to time a sale, or to spread gain recognition through an installment sale, in a way that generally keeps more of the gain in a lower rate bracket. Charitable strategies and step up in basis planning for eventual heirs are two additional areas some investors generally explore, though both generally require specialized advice beyond a general overview like this one. Any capital gains reduction strategy should generally be reviewed with a tax advisor familiar with the investor's full financial picture before a Las Vegas property sale closes.
Combining Strategies for a Larger Sale
Investors selling a larger, more highly appreciated Las Vegas property generally sometimes combine more than one of these strategies at once, for example structuring a partial 1031 exchange that reinvests most of the proceeds while taking some cash out and paying tax on that portion, or pairing an installment sale structure with a partial exchange. These combined approaches generally involve more moving parts and more careful calculation than a single strategy used alone, and they should generally only be pursued with a tax advisor and, where a 1031 exchange is involved, a qualified intermediary guiding the transaction from the start.
Strategies to Approach With Extra Caution
Some capital gains reduction approaches marketed to real estate investors generally carry more risk or complexity than a straightforward exchange or installment sale, including certain structured trust arrangements sometimes promoted as a way to defer or eliminate gain entirely. Any strategy that generally claims to eliminate capital gains tax outright, rather than deferring it under an established framework such as a 1031 exchange, should generally be reviewed with particular skepticism and confirmed independently with a tax advisor before an investor relies on it.
Building a Reduction Plan Around the Investor's Full Picture
The right combination of capital gains reduction strategies generally depends on factors specific to the investor, including other income for the year, whether the investor plans to remain invested in real estate or wants to exit entirely, and how much complexity the investor is willing to manage in the transaction. A Las Vegas investor working through this decision generally benefits from starting the conversation with a tax advisor well before a sale is under contract, since several of the strategies discussed here, particularly a 1031 exchange, generally require specific steps to be in place before the relinquished property even closes.
Frequently Asked Questions
HOW TO REDUCE CAPITAL GAINS TAX FAQS
What is the most commonly used strategy to defer capital gains tax on investment real estate?
Generally a 1031 exchange, which generally allows the gain to be deferred by reinvesting proceeds into a qualifying replacement property.
Does an installment sale reduce the total capital gains tax owed?
Generally not the total amount owed, though it generally can spread the tax liability across multiple years, which may help manage the applicable rate bracket.
Can the Section 121 exclusion be used to reduce tax on an investment property sale?
Generally no, the exclusion generally applies only to a primary residence, not to property held mainly for investment or rental use.
Does Nevada offer any additional state level capital gains reduction?
Nevada generally does not impose a state income tax, so Las Vegas investors generally only need to manage the federal capital gains exposure described in these strategies.
Should a specific capital gains reduction strategy be confirmed before a sale?
Generally yes, every strategy discussed here should generally be reviewed with a tax advisor familiar with the investor's specific transaction before the sale closes.
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