As a landowner, you stand to generate significant profits when selling your land. And while it sure feels great to get a high price for the property sale, the IRS will likely want a piece of the action too. Unlike selling appreciated stocks which allows you to spread out the capital gains by doing so over several years, you won’t have the same luxury when selling investment real estate. Unless you take specific measures to avoid or reduce it, you must report the entire gain amount on your taxes in the same year you sell your property. The question you might be asking yourself is how do i sell land without paying taxes?
Luckily, there are several ways you can avoid capital gains taxes. Read on to learn more about them.
What Are Capital Gains Taxes?
Income taxes on the profit you realize due to an asset’s growth in value are known as capital gains taxes. The capital gains tax is calculated as the difference between your sales price and the cost of the property, minus your selling expenses.
To understand when you’re paying capital gain taxes, it’s critical that you know the distinction between realized and unrealized gains for tax reasons:
- A rise in the value of an asset or investment you hold but haven’t yet sold is known as an unrealized gain. It’s a prospective profit that only exists on paper. Consider the scenario where you purchase a plot of land, and three years later, it is worth 15% more than what you paid for it. Although your investment has grown 15%, you still hold the property, so the gain isn’t recognized.
- A gain is realized when you sell the asset or investment for more than its basis, or at a profit. For instance, if you sell that land for $350,000 after purchasing it for $300,000, you make a profit of $50,000. A capital gains tax is only due when an asset is sold or otherwise realized.
There are two sorts of capital gains tax:
- Short-term capital gains are applicable if you’ve had the property for less than a year. The rates on short-term capital gains are the same as those on a regular income. If your taxable income is low, the tax rate on long-term capital gains can be as low as 0%.
- Long-term capital gains rates only apply to assets held for more than a year. This capital gains tax rate could be 0%, 15%, or 20%, depending on the income and filing status. That being said, long-term tax rates are generally lower than short-term ones.
How Do I Sell Land Without Paying Taxes?
You have a few options to prevent paying capital gains taxes when selling your piece of land. Some of them let you keep all the money, while others lower your taxes or are advantageous to your estate.
Try Deferred Land Sale
With the deferred land sale method, you can move the sale date into the future and place the income in a different year when your taxable income is lower. This is typically done if you’re selling land near the end of your fiscal year. Although most taxpayers base their tax calculations on the calendar year, some assets held under corporations or other similar business entities have a fiscal year that ends on a different day.
Sell the Land in Installments
Similar to deferred sales, installment sales allow you to have transactions spread out over several years. In essence, the buyer purchases parts of the property over several years, one at a time. Depending on the taxable income each year, this can let the seller pay less tax or even avoid paying any at all.
Leverage the 1031 Exchange
The investor can reinvest the funds into a like-kind asset through a 1031 Exchange without paying taxes on the gain. In this process, a third-party middleman manages both the purchase of the replacement property and the receipt of the sale’s revenues. You must choose a replacement property within 45 days and finish its acquisition within 180 days. If these dates are missed, the entire sum is regarded as taxable.
There’s also a possibility for a reverse exchange too. You may purchase the replacement property first and still be eligible for a 1031 Exchange. The same 45-day and 180-day time windows apply in this situation. To be eligible, you must transfer the new property to an exchange accommodation titleholder. Then choose a property to exchange within 45 days. Last thing is to finalize the exchange within 180 days of purchasing the replacement property.
Donate the Land
If you give the land to a charity, you can avoid paying taxes on the capital gains from appreciated land. Once the charity is the new owner, they can decide whether to keep or sell the land. Remember that charitable contributions deductions are capped at a certain percentage of your adjusted gross income. Any excess contributions that aren’t allowed to be written off may be carried over for a maximum of five years.
Balance Gains with Capital Losses
Investors who have both capital gains and losses might use the losses to balance the gains to avoid or pay as little tax as possible. In the same way that long-term losses and gains must be balanced first by long-term gains, you must use losses from short-term assets against short-term gains. You may apply any remaining capital losses to balance any capital gain. If capital losses outweigh your gains, they roll over to subsequent tax years. You may deduct $3,000 of those excess net losses each year from your other regular income.
Leave the Land to Beneficiaries
The cost basis of the assets increases when you leave them to your beneficiaries. This means that they will be able to sell it whenever they want after your death, and their cost base will be the land’s fair market worth at the time of your passing rather than the price you paid for it. If they sell the land soon after your death, they will not be subject to capital gains taxes on the sale. If they decide to keep the land and sell it later, the increased value will be taxed since your death.
How Do I Sell Land Without Paying Taxes: Final Thoughts
You’ll want the property value to rise to make profits when selling land. However, keep in mind that you will be required to pay capital gains taxes on the difference between the sale price and the property’s original purchase price when you sell it. You can minimize or evade capital gains taxes on a land transaction in several ways. The best choice will depend on your individual financial objectives.