Thinking of selling your rental property or converting it into your home to save on taxes? With the right approach, you can reduce or defer capital gains taxes and make the most of your investment. Here’s how strategic tax planning can help:
1. Reduce Taxes by Converting Your Rental Property to Your Primary Residence
If you’ve lived in your rental property as your main home for at least two of the last five years, you may qualify for the Section 121 exclusion. This rule lets you exclude up to $250,000 of profit from capital gains taxes if you’re single, or $500,000 if you’re married and filing jointly. You don’t need to live there for two consecutive years, which provides flexibility. By turning your rental into your home, you can save significantly on capital gains taxes when you’re ready to sell.
2. Defer Capital Gains Taxes with a 1031 Exchange
A Section 1031 exchange, also called a like-kind exchange, lets you defer capital gains taxes by swapping one investment property for another. This means you can reinvest your profits into a new property without facing immediate tax consequences. Using this approach is ideal if you’re planning to grow your real estate portfolio, as it allows you to keep reinvesting without losing a portion of your gains to taxes right away.
3. Combining Both Strategies: When You Can and Can’t
While each tax strategy has unique benefits, there are limitations when combining them.
For instance, if you buy a property through a 1031 exchange, you can later convert it into your primary home and potentially qualify for the Section 121 exclusion, as long as you meet additional criteria. However, if you claim the Section 121 exclusion when selling a primary residence, you can’t use a 1031 exchange on that sale. The Section 121 exclusion applies only to primary homes, and 1031 exchanges are limited to investment properties.
By understanding these rules and using the right strategy, you can make smart moves with your property investments to keep more of your profits. For a personalized approach, consider speaking with a tax advisor to find the best tax planning options for your goals.