Real estate continues to be an appealing asset class for investors as property values rise. While many investors choose to invest in homes or apartment buildings, others prefer to invest in raw land. There are fewer maintenance costs with no tenants to deal with, but there is typically no rent being collected either. If you’re looking to sell your land, you may owe capital gains taxes on the appreciation. Here’s how to avoid capital gains taxes on a land sale.
A financial advisor can help you optimize a tax strategy for your investments.
What Are Capital Gains Taxes?
Capital gains taxes are income taxes owed on the increase in value of an asset. Generally, the income is based on the difference between your sales price less any sales costs and your basis in the property, which includes the purchase price, closing costs and the cost of any improvements made.
Taxes on capital gains have two different rates – short-term and long-term – depending on how long you held the asset for. Short-term capital gains apply if you’ve owned the property for less than a year. While long-term capital gains rates are for assets held for at least 12 months.
Short-term capital gains rates are the same as ordinary income tax rates. Long-term capital gains are taxed at lower rates, as low as 0% if your taxable income is low enough. The table below breaks down long-term capital gains tax rates for 2023:
2023 Long-Term Capital Gains Rates
|Capital Gains Tax Rate||Taxable Income (Single)||Taxable Income (Married filing Separately)||Taxable Income (Head of Household)||Taxable Income (Married Filing Jointly)|
|0%||Up to $44,625||Up to $44,625||Up to $59,750||Up to $89,250|
|15%||$44,626 to $492,300||$44,626 to $276,900||$59,751 to $523,050||$89,251 to $553,850|
|20%||Over $492,300||Over $276,900||Over $523,050||Over $553,850|
How to Avoid Paying Capital Gains Taxes on a Land Sale
As a real estate investor, you have a few options to avoid paying capital gains taxes when selling your land. Some of these options allow you to keep the proceeds, while others reduce your taxes or benefit your estate. Here are six common ways to avoid, minimize or defer paying capital gains taxes:
1031 exchange: A 1031 exchange allows the investor to reinvest the money into a like-kind asset without owing taxes on the gain. This process involves a third-party intermediary that receives the proceeds of the sale and handles the purchase of the replacement property. These transactions have strict deadlines that require you to designate (in writing) a replacement property within 45 days and complete its acquisition within 180 days.
If these deadlines aren’t met, the full amount is considered taxable. When there are proceeds from the sale left uninvested, this is known as “boot.” The boot amount is taxable, while the rest of the gains are deferred until the replacement property is sold.
Deferred sale: With a deferred sale, you can choose to push the sale date into the future to strategically place the income into a different tax year. This is primarily done when selling an asset towards the end of your fiscal year. While most taxpayers use the calendar year for their taxes, some assets held inside corporations or similar business structures have their fiscal year end on a different date. This strategy is appealing to investors who want to push the sale into a future year when their taxable income will be lower.
Installment sale: Installment sales follow the same concept as a deferred sale, except that the sale occurs over multiple years. In essence, the buyer is buying pieces of the property each year over the course of multiple years. This breaks up the taxable income into multiple pieces which may allow for the seller to pay lower taxes or avoid them altogether, depending on the taxable income each year.
Offset gains with capital losses: Investors who have capital gains and losses from their investments can use the losses to offset their gains to avoid or minimize taxes owed. The losses from short-term assets must be used against short-term gains first, and the same is true for long-term losses and gains. Then, any remaining capital losses may be used to offset any type of capital gain.
If you have more capital losses than gains, they carry forward into future years. You may use $3,000 of those excess net losses to reduce ordinary income from other sources each year.
Donate appreciated land to a charity: You can avoid paying taxes on the capital gains from appreciated land if you donate the land to charity. The same is true for stocks. You can deduct the full fair market value of the donated property. Then, the charity may keep or sell the land once they are the new owners. Just remember that charitable donation deductions are limited to a percentage of your adjusted gross income. Any excess contributions that cannot be deducted may be carried forward for up to five years.
Beneficiaries sell after death: When you leave property to your beneficiaries, there is a step-up in the cost basis of the assets. This means that they can sell it at any time after you pass away and their cost basis is the fair market value of the land at your time of death, instead of what you paid for it. This may avoid capital gains taxes on the land sale if they sell it shortly after you pass away. If they hold onto the land and sell it in the future, they only pay taxes on the increase in value from the time of your death.
As a real estate investor, you want your properties to increase in value to create profits when you sell them. However, when you sell a property, you will owe capital gains taxes based on the difference between the sale price and what you paid for it. There are numerous ways that you can reduce or avoid capital gains taxes on a land sale. The best option depends on what your goals are for the money.
Tips for Lowering Your Taxes
- A financial advisor can help you create a tax plan for your investments. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have free introductory calls with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Investors can reduce or avoid taxes when they use specific investment vehicles, such as a 401(k) or Roth IRA. Our capital gains tax calculator helps you estimate how much you’ll owe in taxes based on the sale of stocks, real estate, and other investments. Understanding these tax obligations makes it easier to time the sale of assets and know the impact that they’ll have on your tax bill.
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