Having gone through the nerve-wracking experience of investing in your first commercial property, the next rite of passage for a budding property entrepreneur is to sell that property and reap the fruits of your labor. Selling your first investment property can be a daunting task at first, but also one of the most rewarding once you’ve succeeded. Here are some of the most important things to know before you embark on this adventure.
You Can Offset Your Gains Against Losses Elsewhere
Whether you’ve invested in a house to flip, or set up a rental property for when the time comes to sell, Uncle Sam’s going to want to a cut of the action in the form of capital gains tax and this can take a large chunk of your profits away in one fell swoop. Fortunately, there are a few perfectly legal tricks you can use to mitigate or eliminate these costs if you know your way around the US tax code.
Let’s say that in addition to your investments in property, you also have a stock market portfolio and that when the time comes to sell your property you make a cool $75,000. For those in the 25 to 35% tax bracket, the capital gains tax is 15%, and for those in the higher tax bracket, this rises to 20%; a pretty significant hit to your profits. However, you can offset this against any losses incurred elsewhere in your portfolio, in this case on the stock market. Let’s say it’s been a bad year and your losses there are $100,000. You can pair these gains and losses to offset the tax on your $75,000. This is known as tax-loss harvesting.
You Can Take Advantage of the 1031 Tax Code
The 1031 tax code is an important tool for property investors. The Internal Revenue Service (IRS) allows for you, the investor, to sell an investment, in this case property, and take the proceeds of that sale and invest them in another property without paying any tax on the gains. There is a clock on this, however; you have 45 days from the sale of one property to reinvest the proceeds in another property which you have 180 days to acquire.
As you get ready to sell one property, you should be on the lookout for 1031 exchange investment offerings. Be aware, though, that there are a few restrictions on the properties you can invest in if you intend to claim it as a 1031; the property has to adhere to the IRS like-kind rule and both properties must have been acquired to generate income. In other words, you cannot sell your primary residence and invest the money under section 1031, and you cannot claim the proceeds of the sale of a commercial property if you then invest those proceeds in a property that becomes your primary residence.
You Can Shield Yourself From Personal Risk
Incorporating as a shield, as the practice is known, is becoming increasingly popular as a means to protect your personal assets from liability should there be any unforeseen problems with your rental property or litigation from a client. Incorporating essentially involves putting a corporation between you and your tenants and is a smart option once you start making some serious cash. It’s something you should educate yourself on early in your real estate career. Until this becomes a viable option, consider converting your real estate holdings into a small business. Some states also allow real estate investors to open a limited liability company (LLC) for each separate property they own, and while this won’t lower your tax bill it will protect your personal assets.
Further down the line, when your gains are significantly higher than your losses, you can hire an experienced accountant who will know all the above tricks and many more. Until then, though, you can never know too much! Be sure to do your research before committing to your first sale to ensure you can keep as much of the profits as possible.