Guide to Capital Gains on Real Estate

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Everything You Need To Know About Capital Gains Tax on Real Estate

Investing in real estate can be lucrative, but in order to maximize your profits, you need to understand the tax implications, particularly when it comes to capital gains.

Investors should be aware that taxes can significantly impact their return on investment (ROI) and even affect cash flow. Knowing how different aspects of real estate transactions are taxed is essential for making informed decisions.

Learning about capital gains in particular can help investors decide on when to buy or sell property. Having this knowledge allows for strategic investment decisions that align with your long-term financial goals.

Whether you’re a seasoned investor or just dipping your toes into the property market, navigating capital gains can seem daunting. But here we will provide a comprehensive guide on capital gains in real estate.

What Are Capital Gains?

Capital gains refer to the profits made from the sale of a capital asset, such as real estate, stocks, or bonds. Almost any type of asset you own is considered a capital asset. This includes items purchased for personal use such as furniture as well as investment assets like stocks and bonds. [1]

In real estate, capital gains are the difference between the purchase price (or the cost basis) of a property and its selling price. [1]

Capital gains in real estate serve as a measure of the investment’s appreciation over time. As properties typically appreciate in value, the capital gains realized upon sale represent the increase in the property’s worth since its purchase. This appreciation can be influenced by various factors such as market demand, location desirability, and property improvements.

The Internal Revenue Service (IRS) taxes individuals on capital gains in certain circumstances. [1]

Capital gains also play a crucial role in incentivizing investment in real estate. Investors are motivated to buy properties with the expectation of earning a return on their investment through capital appreciation.

The potential for capital gains encourages individual investors and businesses to allocate funds towards real estate, thereby stimulating economic activity in the property market.

Calculating Capital Gains

To calculate capital gains, one needs to subtract the original purchase price, also known as the cost basis, from the final selling price. The resulting amount represents the capital gain.

First you need to determine your basis, also known as the purchase price plus any commissions or fees paid. Next, determine your realized amount: this is the sale price minus any commissions or fees paid. Subtract the basis from the realized amount to determine the difference. [2]

If you sold the asset for more than you paid, then it is a capital gain. But if you sold the asset for less than you paid, it is a capital loss. [2]

It’s important to consider various factors that can affect the calculation of capital gains. For example, if the asset was held for more than one year before being sold, it’s typically classified as a long-term capital gain, which often comes with preferential tax rates compared to short-term capital gains.

On the other hand, if the asset was held for a year or less, it’s considered a short-term capital gain and is usually taxed at the individual’s ordinary income tax rate.

In some cases, adjustments have to be made to the cost basis to account for factors like commissions, fees, and any improvements made to the asset over time. Accurate calculation of capital gains ensures compliance with tax laws.

Understanding Capital Gains Tax

Once you’ve determined your capital gain, it’s essential to understand how it will be taxed. In the US, capital gains tax rates vary depending on how long you’ve held the property:

Short-Term Capital Gains

Short-term capital gains refer to profits earned from the sale of assets that have been held for one year or less. These gains are subject to higher tax rates than long-term capital gains.

The tax rate for short-term capital gains is typically based on an individual’s ordinary income tax rate, which can range from 10% to 37%, depending on income level. Because short-term gains are taxed at higher rates, investors often aim to hold onto their assets for longer periods to qualify for the more favorable long-term capital gains tax rates. [1]

Long-Term Capital Gains

If you’ve owned the property for more than one year, your capital gain is considered long-term. One of the key advantages of long-term capital gains is the preferential tax treatment they receive compared to short-term gains. In many tax jurisdictions, long-term capital gains are taxed at lower rates, incentivizing investors to hold onto their assets for longer periods. [1]

The taxation of long-term capital gains can also vary depending on factors like the investor’s income level and the type of asset sold. This tax advantage can significantly impact an investor’s ROI, which is why it is often incorporated into investment strategies.

Strategies to Minimize Capital Gains Tax

While capital gains tax is inevitable when selling real estate, there are strategies you can employ to minimize its impact:

Utilize 1031 Exchanges: A 1031 exchange allows you to defer capital gains tax by reinvesting the proceeds from the sale of one property into another similar property. This strategy is particularly beneficial for investors looking to upgrade or diversify their real estate portfolio without incurring immediate tax liabilities. [3]

Take Advantage of Capital Gains Exclusions: Homeowners can utilize capital gains tax exclusion from the sale of their primary residence if certain conditions are met. Please discuss such exclusions with your tax professional.  [4]

Strategic Timing: Consider the timing of your property sales to take advantage of lower tax rates. If you anticipate a significant increase in your income in the future, selling when your tax rate is lower can result in substantial tax savings.

Offset Gains with Losses: If you have other investments that have incurred capital losses, you can offset your capital gains by selling those investments. This strategy, known as tax-loss harvesting, can help reduce your overall tax liability.

Consult with a Tax Professional

Understanding capital gains is essential for any real estate investor. By familiarizing yourself with the tax implications and implementing strategic tax planning strategies, you can maximize your profits and minimize your tax liabilities in the world of real estate investment.

But while this guide provides an overview of capital gains in real estate, tax laws can be complex and subject to change. Therefore, it’s crucial to consult with a qualified tax professional or financial advisor to develop a personalized tax strategy tailored to your specific circumstances.

The Best Real Estate Investment for Accredited Investors: Multifamily Syndication

Understanding capital gains in real estate can help investors maximize their profits and make informed decisions that will bring them closer to their financial goals. Multifamily syndication is a great way to partake in managed real estate investing and still partake in the tax benefits of real estate investing. 

If you are an accredited investor looking for a passive investment in real estate, one of the options you need to consider is multifamily syndication.

In real estate, a syndication deal is when multiple investors pool their financial resources together to buy a single real estate property. This is arranged by a syndicator, also known as a sponsor, who serves as the general partner (GP) in the deal. [5]

This can be done with any type of real estate, but multifamily syndication is the most popular among investors because of the strong and predictable cash flow generated by multifamily properties. Apartment communities and condominiums have plenty of units and lots of tenants, meaning they are a good source of monthly rental income. These properties are also mostly unaffected by vacancies because there are plenty of units contributing to the cash flow. Unlike a single family property, multifamily real estate properties will not stop producing income even if one or two tenants leave.

Multifamily properties are also generally more expensive because of their sheer size and number of units. Therefore they are more difficult to acquire for a lone investor. These properties have a large barrier to entry, but multifamily syndication makes them more accessible.

By pooling their money with other investors, real estate investors can participate in these larger deals without buying the entire property on their own.

The syndicator puts the deal together, locating the investment property and conducting due diligence before looking for investors who will participate. They will essentially create and execute the business plan from start to finish. As limited partners (LPs), investors have limited responsibilities in the syndication.

Investors provide most of the capital needed to acquire the property. They also pay certain fees to get the syndication deal running. In return, they get a percentage of the property’s monthly cash flow. Depending on the deal structure, they also earn a share of the property’s equity upon resale. [5]

Every deal is different, so investors still need to perform their due diligence before joining a syndication deal. [5]

The profit split will be detailed in the syndication agreement or the private placement memorandum (PPM). Profits are typically distributed on a monthly or quarterly basis, again depending on the deal structure.

Unlike traditional real estate investments where you have to take on the responsibilities of a landlord, multifamily syndication is a true passive investment. The syndicator takes care of property management once the deal is in place.

Investors can just sit back, relax, and enjoy their investment as it does not require a significant time investment nor any experience with property management. You don’t have to worry about dealing with tenants or handling emergencies.

Beyond their initial investment, investors have no further liabilities in the syndication deal. They only have to worry about their share of the capital instead of taking on the risk of an entire multifamily property. It is a much safer way to invest in real estate.

Work With BAM Capital for the Best Multifamily Real Estate Syndication Deals

Most syndication deals are exclusive to accredited investors. This is because syndication deals still require a significant amount of capital upfront. And since these deals tend to last for several years, investors should know that they will not have access to this capital for a long time. They need to be comfortable with a bit of illiquidity.

Accredited investors have the investing knowledge, experience, and financial sophistication needed to assess these deals properly. With their income and net worth, they also have the financial safety net necessary to protect themselves in case these deals do not work out. Regular investors may not have this kind of protection, which is why the US Securities and Exchange Commission (SEC) limits access to these investments.

Investors should also know that as a passive investment, multifamily syndication will involve taking a backseat to the syndicator who will be executing the business plan from start to finish. Investors need to work with a syndicator they trust, because they are the ones who will be making all the decisions moving forward.

If you want to work with a reliable syndicator with a track record for excellence, work with BAM Capital.

BAM Capital is an Indianapolis-based syndicator with a reputation for being a leader in its industry. They focus on Class A, A-, and B++ multifamily real estate properties, specifically those that have in-place cash flow and proven upside potential. [6]

BAM Capital’s award-winning investment strategy creates forced appreciation while mitigating investor risk. This is the best syndicator to work with if you are interested in adding multifamily real estate to your investment portfolio. In fact, BAM Capital now has over $700 million AUM and 5,000+ units.

As a vertically-integrated company, BAM Capital can handle every step of the syndication process, from acquiring the properties to renovating and managing them. [6]

No investment is without risk. Make sure to consult your investment advisor or speak to a BAM Capital investment team member before making any financial decisions.

For accredited investors who want to enjoy the passive income and all the other benefits of being in a multifamily syndication, schedule a call with BAM Capital and invest today.

Sources:

[1]: https://www.investopedia.com/terms/c/capitalgain.asp

[2]: https://www.hrblock.com/tax-center/income/investments/how-to-figure-capital-gains-tax/

[3]: https://www.investopedia.com/articles/06/section1031exchange.asp

[4]: https://www.kiplinger.com/taxes/capital-gains-home-sale-exclusion

[5]: https://multifamilyrefinance.com/apartment-investing-blog/multifamily-syndication#important

[6]: https://capital.thebamcompanies.com/