How to Avoid Capital Gains Tax on Investment Property Sales

Selling an investment property can result in significant capital gains tax, but there are strategies to help mitigate this burden. Learning how to avoid capital gains tax on investment property sales requires an understanding of specific techniques, such as the 1031 exchange that allows you to defer taxes by reinvesting in a similar property. Additionally, leveraging opportunities like offsetting gains with losses and maximizing primary residence exclusions can further reduce your tax liability. By employing these methods, investors can keep more of their profits while making strategic decisions about their property investments.

If you want to avoid capital gains, a financial advisor can help you create a financial plan to lower your tax liability.

Understanding Capital Gains Tax

Capital gains tax is levied on the profit made from the sale of an asset, such as a stock or piece of real estate. This tax is calculated based on the difference between the asset’s purchase price (cost basis) and its selling price.

The tax rate on capital gains can vary, depending on how long you held the property.

Short-term capital gains, which are assets held for one year or less, are taxed at regular income tax rates.
Long-term capital gains are held for more than one year and benefit from lower tax rates that typically run between 0% to 20%, depending on your income bracket.

How to Avoid Capital Gains Tax on Investment Property

Understanding how to avoid capital gains tax on investment property sales can save you a substantial amount of money. These five strategies may help.

1031 Exchange

A 1031 exchange is named after Section 1031 of the Internal Revenue Code. It allows you to defer paying capital gains taxes by reinvesting the sale proceeds from your investment property into a similar property. This strategy is beneficial for real estate investors who want to upgrade their portfolio without an immediate tax burden.

In order to avoid capital gains by buying another home, the new property must be of equal or greater value, and the transaction must be completed within specific time frames, which is typically 180 days.

Primary Home Exclusion

If your investment property has been your primary residence for at least two of the last five years, you may qualify for the primary home exclusion, also known as the Section 121 Exclusion. This tax benefit allows you to exclude up to $250,000 of capital gains if you are single and up to $500,000 if you are filing jointly.

This strategy can be particularly advantageous if you plan to convert an investment property into your primary residence before selling.

Use Tax-Loss Harvesting

Tax-loss harvesting involves selling underperforming investments to offset the gains from your property sale. This strategy can help reduce your overall taxable income. By carefully managing your investment portfolio, you can realize losses that can be deducted against the gains from the sale of your property, potentially lowering your tax liability.

This approach requires a good understanding of your overall investment performance and careful planning.

Installment Sale

An installment sale allows you to spread the capital gains tax over several years by receiving the sale proceeds in installments. This method can be particularly useful if you anticipate being in a lower tax bracket in future years. By deferring the bulk of your capital gains tax, you can better manage your tax obligations and potentially pay less overall.

However, this strategy requires the buyer’s agreement and a well-structured contract to ensure compliance with IRS regulations.

Invest in Opportunity Zones

Opportunity Zones are designated areas in need of economic development. They also offer significant tax incentives for investors.

By reinvesting your capital gains into an opportunity zone fund, you can defer or even reduce your capital gains tax. Investments held for at least 10 years can benefit from a permanent exclusion from taxable income on new gains.

This strategy not only helps reduce tax liabilities but also supports community development and revitalization.

Timing Strategies to Minimize Capital Gains

Clients meeting with a financial advisor to discuss strategies that can help them avoid capital gains.

The timing of your investment property sale can also affect how much tax you owe. Timing the sale to match your income levels or to align with market conditions can help lower your capital gains exposure.

Sell in a low-income year. If you expect a drop in income, such as a sabbatical, retirement or career change, you may want to plan your property sale for that year. Lower income could place you in a lower capital gains tax bracket, reducing your overall tax bill.
Hold for over one year. To qualify for long-term capital gains tax rates, you must hold the property for more than one year. Rates are lower than short-term rates, but selling too early could result in a higher tax rate based on your ordinary income.
Stagger sales if you own multiple properties. Instead of selling multiple investment properties in a single year, consider spreading the sales across several tax years. This can keep each year’s capital gains lower, potentially avoiding a higher bracket or triggering additional taxes like the Net Investment Income Tax.

Smart timing does not eliminate taxes, but it may reduce them. Planning around your income level and holding period can help preserve more of your investment gains.

Other Tax Considerations When Selling an Investment Property

When selling rental properties, there are many tax implications to consider beyond capital gains taxes.

Depreciation recapture: Depreciation allows property owners to deduct a portion of the property’s value over time, reducing taxable income. However, upon selling the property, the IRS requires recapturing this depreciation, taxing it at your marginal income tax rate up to a maximum of 25%.
Passive loss limitations: If you have accumulated passive losses from rental properties, selling a property could trigger the ability to deduct these losses. In some cases, rental losses that were previously limited can be used to offset other taxable income in the year of the sale.
Net Investment Income Tax (NIIT): This 3.8% NIIT tax applies to individuals with a high net investment income, including rental income. If your adjusted gross income exceeds certain thresholds ($200,000 for single filers and $250,000 for married couples filing jointly), the NIIT could impact your rental property sale proceeds.
State and local taxes: Each state has its own tax regulations, which may include transfer taxes, recording fees and local income taxes on the sale. These taxes vary widely and can significantly affect the net proceeds from the sale.
Alternative minimum tax (AMT): For some property owners, the AMT may apply. Using accelerated depreciation methods instead of straight-line methods, you can classify the revenue from a sale as regular income instead of capital gains. This may push you beyond the threshold for AMT tax exemptions. In 2025, single filers earning $626,350 in income and married taxpayers filing jointly with $1,252,700 in income are not eligible for AMT exemptions and are subject to greater tax liability.

Bottom Line

Real estate investors reviewing the plan for an investment property.

Knowing how to avoid capital gains tax on investment property sales involves both strategic planning and a strong understanding of available tax benefits. Options like the 1031 exchange, primary home exclusion, tax-loss harvesting and installment sales can significantly reduce your tax burden. Additionally, investing in opportunity zones can offer substantial incentives while contributing to economic development.

Ask a financial advisor the best way to prepare for your property sale to maximize earnings and minimize tax liability.

Tax Planning Tips for Investors

If you’re building a real estate investment portfolio, a financial advisor can help you plan for taxes. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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