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How to Limit Your Capital Gains Tax after a House Sale

As a real estate investor, you can’t prevent your capital gains tax obligations from mounting up. This holds especially true in a short-term purchase and sale.

Short-term Sales

If a property is sold earlier than three years after it was bought, short-term capital gains tax applies. And it’s going to be hefty, with the gain from this type of transaction being counted as part of the taxable income for that particular year and will be computed accordingly. It is impossible to exempt the gain from this (short term capital gain is computed by deducting total property expenditures from the sale price).

Long-term Sales

A property sold after the third year of its initial purchase will be subject to long-term capital gains tax. The formula for calculating short-term gain is the same as that used to calculate long-term gain, except that both the initial investment and overheads of the latter are adjusted for inflation, a process referred to as indexation.

The good news is income from long-term gains may also be eligible for particular tax exemptions. If you’re earning lower than the taxable limit, only the part of the long-terms gains in excess of the limit is going to be taxed. If you sell an inheritance property or a property that was given to you as a gift, you still have to pay taxes.

Purchasing a Property with Gains

When buying a residential property with the money you earned from selling a house, the amount you invested in or gained from that transaction – whichever is less – will be tax exempt. There are, however, certain limitations, as the property in which this amount is invested must be bought either one year before or two years after the first property’s sale.

If you invest your gains in building a house, you can also get a tax deduction, where the costs of the building and the land will be considered. But you have to make sure that the construction is done within three years following the initial sale. If the income is obtained from the sale of land, you will be allowed to claim complete tax deduction, provided the proceeds were all spent on building a residential property. But you have to make sure that you don’t own more than one house before you begin investing in the new property.

As you can see, there are several ways for you to save on capital gains taxes. The key is to have a good grasp of how these opportunities can be used to your full advantage. These days, there is no excuse for misinformation. The Internet offers so much, as long as you choose the websites you read from, you will be safe. Of course, to avoid misinterpreting tax laws or rules and regulations, it’s best to speak to a real estate lawyer.