Capital gains taxes on real estate can significantly erode profits, but with informed planning and strategic execution, investors can reduce their liabilities and retain more of their earnings.

There are practical ways to minimize the taxes owed on your capital gains, regardless of if you’re selling residential property, commercial investments, or undeveloped land. Below, we show how.

Understand Real Estate Capital Gains Taxes

Real estate capital gains taxes are assessed on the profit made from selling a property. The tax rate depends on several factors, including how long you’ve held the property and your overall income. Properties held for less than a year are taxed as ordinary income, while those held longer are subject to long-term capital gains rates, which range from 0% to 20%.

According to the Congressional Budget Office (CBO), capital gains realizations have historically accounted for roughly 5% to 10% of total individual income. Understanding these rates and thresholds is critical for strategic tax planning. For example, married couples filing jointly with taxable incomes under $89,250 often avoid long-term capital gains taxes altogether.

Make Use of Tax Exemptions

Certain exemptions can help taxpayers reduce their real estate capital gains. One of the most widely used is the home sale capital gains exclusion, which allows individuals to exclude up to $250,000 ($500,000 for married couples) of profit on the sale of a primary residence. To qualify, you must have lived in the home for at least two of the past five years.

The National Association of Realtors has confirmed that a majority of home sellers qualify for the primary residence exclusion, emphasizing its importance as a tax-saving strategy.

Also, some exceptions may apply to properties sold because of health problems, moving jobs, or unexpected events, even if you don’t meet the full two-year residency requirement.

Utilize 1031 Exchanges

For investment properties, 1031 exchanges are one of the most effective ways to defer capital gains taxes. When you reinvest the proceeds from a property sale into another “like-kind” property, you can defer tax liabilities indefinitely. The IRS defines “like-kind” broadly, allowing investors to exchange residential rentals for commercial buildings or undeveloped land.

The share of 1031 exchanges ranges from 10-20% of all commercial real estate transactions, according to an EY study conducted a few years ago. Those real estate investors who decide to embark on this strategy typically cite substantial tax savings and portfolio growth as the primary benefits.

However, strict timelines apply—replacement properties must be identified within 45 days and purchased within 180 days of the original sale.

As an aside, remember that timing the sale of real estate can have a tremendous impact on the capital gains taxes you pay. If you sell up during years of lower income, then this would place you in a lower tax bracket, reducing your long-term capital gains rates. Strategic planning is absolutely key to making the most of the opportunities that 1031 provides.

Offset Gains with Losses

Another practical strategy for reducing real estate capital gains taxes is tax-loss harvesting, which involves selling underperforming assets to offset gains. For instance, if you’ve experienced losses in the stock market, those losses can directly offset the gains from a property sale.

Tax-loss harvesting has saved American taxpayers many billions of dollars in realized capital gains taxes. However, keep in mind that offsetting gains with losses can only be applied to assets in the same tax year, and the IRS imposes limitations on the amount of deductible losses.

Adopt Long-Term Strategies to Minimize Tax Liabilities

Planning for long-term real estate investments can significantly impact your ability to manage capital gains taxes. One effective approach is to identify and utilize tax-advantaged opportunities that align with your investment goals.

For example, holding properties for longer durations not only means you benefit from reduced long-term capital gains tax rates but also grants you extra time to implement strategic improvements that can increase the value of your property.

Another long-term strategy involves incorporating depreciation into your tax planning. Depreciation allows property owners to deduct a portion of the asset’s value annually, lowering taxable income during the holding period. A 2023 IRS analysis revealed that depreciation deductions helped investors save an average of $8,500 annually on taxable income.

However, it’s essential to plan for depreciation recapture, which can increase tax liabilities upon sale if not deferred through strategies like a 1031 exchange.

Investors should also consider succession planning. Gifting property to heirs or using trusts can mitigate tax burdens, especially when paired with stepped-up basis rules, which reset the asset’s value at the time of inheritance. This method not only reduces your current tax obligations, but also creates opportunities to preserve wealth across generations.

Incorporating Charitable Donations

Donating real estate or appreciated assets to qualified charities can also help reduce capital gains taxes while supporting a good cause. When you give a property that has gone up in value, you can avoid paying capital gains tax on the increase in value. You can also get a charitable deduction for the fair market value of the property.

A 2023-24 report by Fidelity Charitable highlighted that donors contributed $2.7 billion in appreciated assets, with significant tax benefits reported across all income brackets. This strategy is particularly effective for properties that have substantially increased in value and may otherwise result in high tax liabilities upon sale.

Choosing the Right Strategy For Your Needs

Reducing real estate capital gains taxes requires careful planning and execution. When you use exemptions and 1031 exchanges, take back gains with losses, and give money to charity, you can keep more of your investment profits while staying in line with tax rules.

Each strategy comes with its own benefits. David’s Family CPA can make sure that your chosen approach is fully aligned with your long-term financial goals and your current and likely future circumstances.