A lot of people’s savings are from the money they earn in their trades. The majority of the people are unaware about investing and its benefits. The money placed in a thoughtful investment can grow faster than the money stored in the bank. Investments also affect the economy of the country. When investments are available for businesses, they begin to expand, become more innovative, and offer better products or services. In addition, investments safeguard money from inflation.
Managing a portfolio and diversifying it is the best way to balance rewards and risks. The most popular option for investors is to invest in the stock market because it is easier to manage and diversify. According to Kristina Wallender of Realty Shares, 25% of Americans believe that stocks are the top performing asset class since 2000 and only 16% believes that real estate is the top-performing asset class. However, these statistics have been starting to change since real estate investment is starting to get popular with younger investors. In relation to this, capital gains and capital gains tax is relatively a new item in some of the investors’ financial sheets.
Capital gain is the gain that an investor makes during the sale of capital assets such as stocks, real estate, coins, mutual funds, bonds, precious metals, fine art, and other collectibles. Capital gain tax is the tax that is levied to the gain after the transaction is completed and the investor got his or her capital gains. If there is a loss in the transaction, then the investor will instead get a capital loss, which is not taxed and will be a deductible item in the following years.
Treatment of Capital Gains and Capital Loss
For example, an investor manages to sell his real estate property amounting to $8,000 for $10,000. He has a capital gain of $2,000. The $2,000 will be taxed based on how long did the investor hold the asset before selling. Short-term selling or selling properties within a year will be taxed based on the investor’s regular income tax rate. Long-term capital tax gains, or those held for more than a year, will be taxed between 0% to 20% based on the income tax bracket. Capital gain tax is not applicable for properties counted as a primary residence.
However, when the same property has been sold for $4,000, he will instead get a capital loss of $4,000. The amount of capital loss that can be deducted every year is only $3,000. In this example, the $4,000 will be deductible in 2 years; $3,000 for the first year and $1,000 for the second year.
How To Avoid Capital Gains Tax?
In order to maximize the profit from every transaction, a lot of investors wishes to avoid or minimize the amount of capital gains tax. There are ways to avoid the capital gains tax such as Charitable Remainder Annuity Trusts or Charitable Remainder Unitrusts, which are irrevocable. However, more people find ways to minimize the tax amount instead.
- Sell after a year
One such technique is waiting for more than a year before selling the property. In this case, the tax rate will fall into the rate of 0%, 15% or 20% depending on the tax bracket.
- Pile up your failures
If the investor is what is known as a “house flipper” or a person who sells real estate assets for gains, sales which turned into capital losses is still not a bad thing. These transactions create new experiences and learning. One more thing it creates is a tax deduction. Capital losses are tax deductible. A maximum of $3,000 a year can be deducted. But if the losses are greater than $3,000, the remaining will be deducted throughout the years.
- Don’t rent out properties for too long
This often happens when the property is not sold at the time frame preferred. Properties depreciate when used, and thus, its purchase value. The depreciated property may lose its value; however, the capital gains tax will remain the same.
- Sell when income is low
Since the taxation rate is based on the income bracket of the investor, it is better to sell a property while income is still low. This causes lower rates for capital gains tax. In addition, those who are in 10% and 15% income tax brackets will not pay capital gains tax.
Capital gains tax is something that a lot of investors are happy to minimize. However, when new to real estate investing, they might not know strategies that maximize profit by minimizing the tax. In this case, professional help is needed and is recommended for investors most of the time.