Rental properties offer a convenient way to increase assets. However, capital gains tax may play a significant role in rental property landlords' investments. The exact amount you may owe in capital gains tax can vary based on a number of factors.
In this article, we will discuss strategies you can use to help avoid paying capital gains tax. Learn how to reduce your capital gains tax with these three simple steps.
What Are Capital Gains Taxes?
Capital gains taxes are taxes owed after the sale of an asset. Depending on how long you’ve held onto the investment property, you'll pay tax on the asset. There are two capital gains taxes: long-term capital gains taxes and short-term capital gains taxes.
Long-term capital gains taxes apply to assets you’ve held for more than one year. These taxes have three tax rates which will determine the amount you’ll owe.
Short-term capital gains taxes apply to assets you’ve held for one year or less. In contrast to long-term capital gains, profits from short-term capital gains are taxed as ordinary income.
How Do Capital Gains on Investment Properties Work?
Capital gains for investment properties work like other assets. A capital gain occurs when you sell an asset for more than you paid. Capital gains are realized when you subtract the purchase price from the sale price.
You’ll pay for long-term capital gains and short-term capital gains using tax return forms.
3 Strategies to Reduce or Lower Capital Gains on Rental Properties
You can use three strategies to lower or reduce capital gains tax on rental properties: 1031 exchanges, offsetting losses with gains, and rental property conversion.
1. 1031 Exchanges
The first strategy you can use to lower capital gains tax involves 1031 exchanges. You can use section 1031 to sell a rental property while purchasing a like-kind property.
Like-kind properties are properties of the same character or nature, even if their grade or quality differs.
If you defer paying capital gains taxes using 1031 exchanges, you’ll have to remember three deadlines:
2. Offset Losses with Gains
Another way to lower capital gains tax is to offset losses with gains. This option allows you to subtract losses from realized capital gains from a rental property sale.
You may consider this option if you’ve had capital losses in a tax year.
3. Convert Your Rental to a Primary Residence
The third strategy you can use to lower capital gains tax is converting your rental into a primary residence.
By converting your rental into a primary residence, single taxpayers can exclude up to $250,000 from the sale of the property. Married taxpayers can exclude up to $500,000 if they’re married and filing jointly.
There are two things to know about qualifying for rental conversion into a primary residence. First, you must have lived in their primary residence for two out of five years before the sale. Second, the years you must live in your primary residence don’t have to be consecutive.
How to Calculate Capital Gains Tax on a Rental Property
Capital gains tax on a rental property is calculated by subtracting the property's cost basis from the sale price of the property. Your cost basis is the original purchase price plus any improvements made to the property. The total amount is then taxed at the required capital gains tax rate.
2023 short-term capital gains tax rates
The following table provides an overview of the 2023 short-term capital gains tax rates for different taxable income ranges based on the taxpayer's filing status.
| Tax Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
| 10% | $0 to $11,000 | $0 to $22,000 | $0 to $11,000 | $0 to $15,700 |
| 12% | $11,001 to $44,725 | $22,001 to $89,450 | $11,001 to $44,725 | $15,701 to $59,850 |
| 22% | $44,726 to $95,375 | $89,451 to $190,750 | $44,726 to $95,375 | $59,851 to $95,350 |
| 24% | $95,376 to $182,100 | $190,751 to $364,200 | $95,376 to $182,100 | $95,351 to $182,100 |
| 32% | $182,101 to $231,250 | $364,201 to $462,500 | $182,101 to $231,250 | $182,101 to $231,250 |
| 35% | $231,251 to $578,125 | $462,501 to $693,750 | $231,251 to $346,875 | $231,251 to $578,100 |
| 37% | $578,126 or more | $693,751 or more | $346,876 or more | $578,101 or more |
2023 long-term capital gains tax rates
The following table shows the income ranges for the long-term capital gains tax rates for the year 2023 based on the taxpayer's status.
| Filing Status | Taxable Income for 0% Tax Rate | Taxable income for 15% Tax Rate | Taxable Income for the 20% Tax Rate |
| Single | Up to $41,675 | $41,676 to $459,750 | $459,751 or more |
| Married, Filing Jointly | Up to $83,350 | $83,351 to $517,200 | $517,201 or more |
| Married, Filing Separately | Up to $41,675 | $41,676 to $258,600 | $258,601 or more |
| Head of Household | Up to $55,800 | $55,801 to $488,500 | $488,501 or more |
Lower Your Tax Bill with 1-800Accountant On Your Side
Capital gains tax can vary because of a lot of factors. Whether your capital gain is long-term or short-term, you’ll want to pay the tax bill when tax season arrives.
When it’s time to reduce your rental income taxes, make sure you work with accountants who specialize in the real estate industry. Work with the professionals at 1-800Accountant to reduce your rental tax liability today.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.
