You've probably heard the saying before "nothing in the world is guaranteed except death and taxes." Well... we may have to add an asterisk to that old adage. Seasoned real estate investors know that real estate is not only a powerful vehicle to earn and grow your wealth but also a powerful means to preserve wealth by deferring (or even eliminating) taxes.
You Gain Some You Lose Some
Capital gains can arise from transactions involving almost any asset you own for personal or investment use. Capital gains and losses as defined by the IRS (https://www.irs.gov/taxtopics/tc409) is the difference between the adjusted basis in the asset and the amount you realized from the sale of that asset. The basis is usually the cost (at purchase and any subsequent improvements). The amount that is realized is the difference between that cost and the sales price. If the asset has increased in value you will have a capital gain. If the asset decreased in value you will have a capital loss. If you have a loss on the asset or break even you will not owe any taxes. If you however have a gain, you will have to pay taxes based on the timing of the sale and your relative tax bracket.
Tax rules and percentages change on an annual basis, so I will provide a general explanation of how capital gains are taxed.
Short Term: Short term gains/losses are gains/losses which occur on assets that you have owned for less than one year. As this income is earned in such a short term it is viewed akin to earned income and taxed in line with your ordinary income tax rate.
Long Term: For gains that occur on assets that you have owned for more than one year would be considered long term. Depending on your tax bracket and filing status you would be subject to 0%, 15% or 20% tax on that income.
Ways capital gains taxes can be deferred in syndications:
Hold Period: Syndications almost always last more than one year, thus the gains on sale of the asset would be subject to long term capital gains tax which are at a lower rate than your earned income tax rate.
Ongoing distributions - Initial distributions are accounted for as return of capital as opposed to passive income gains. A return of capital is not a taxable event, as noted before your tax liability will come from the difference between your cost (capital invested) and the sale price of the asset.
Sale (disposition/exit) of the property – You may have heard of 1031 exchanges – 1031 exchanges are named after Section 1031 of the IRS Code. Section 1031 states that a seller of investment property is able to reinvest the proceeds (gains) from the sale of investment property into a similar “like kind” property of equivalent or greater value. This exchange has to take place using an independent “qualified intermediary” and occur within a specified time restriction as designated by the IRS code. If the transaction is completed and the gains reinvested in line with the IRS Code section 1031 these gains will be tax free. Taxes can indefinitely be deferred if an investor were to continually perform 1031 exchanges each time an asset is sold.
Opportunity Zones: When congress passed the Tax Cuts and Jobs Act of 2017 there were incentives created for investors to make long term investments in “opportunity zones” - low income urban and rural neighborhoods in the US. Capital gains can be invested in these opportunity zones and pending how long the investor holds their investment in the asset they will get a reduction in their tax bill on subsequent gains. Ultimately if the investor holds the asset for more than 10 years they will pay zero capital gains tax on the gains related to that asset.
When you start making money, you also start getting taxed more. Speak with your tax accountant to ensure that you are taking the appropriate tax planning steps
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This article was originally published on investwithare.com and is being reproduced here for the benefit of our members.
DISCLAIMER: InvestUp! and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Consult your own personal tax, legal and accounting advisers before engaging in any transaction.