Capital Gains Taxes and Real Estate Investing

There are only a few things in life we can be certain about. Taxes are at the top of the list. As a real estate investor, the term “tax” might instantly cause a headache. We get it. 

Capital gains taxes are a critical consideration for real estate investors, impacting profitability from the sale of properties. Navigating these taxes can seem overwhelming, but understanding how they work is key to maximizing your returns.

Real estate investing has become the top option for long-term investing and wealth-building for 36% of Americans – a higher percentage than stocks and mutual funds. 

Most real estate investors will work with a tax advisor or accountant to formulate a tax strategy that accounts for capital gains taxes. Whatever stage you’re at in your investing journey, it’s crucial to consider capital gains tax. This tax is related to the sale of an asset and depends on the income of the filer. For 2025, the long-term capital gains tax rate is set at 0%, 15%, and 20% of the total profits.

We’re sharing everything that real estate investors need to know about capital gains taxes, including strategies to minimize capital gains taxes on real estate investments.

What are Capital Gains Taxes?

Capital gains taxes are a federal tax policy that applies to profits from the sale of an asset. The rate of capital gains tax depends on the individual’s tax bracket for that income year. 

Real estate investors are subject to two types of capital gains taxes: short-term (on assets held for one year or less) and long-term (on assets held for over one year). The key difference is that long-term capital gains tax rates are typically lower, which is why holding properties longer can save you money.

Due to the nature of real estate investing, you’ll encounter capital gains taxes when selling a property. As a real estate investor, whether you’re flipping properties or managing long-term rental portfolios, capital gains taxes will affect your profits when you sell. Understanding how to minimize this tax is crucial for optimizing your returns

The tax rate for short-term capital gains is determined by the individual’s ordinary income bracket. Most investors will pay a higher level of ordinary income tax than capital gains tax unless they fall into the highest category of taxpayers. Capital gains tax rates may differ at a state and federal level, so it’s best to consult a local tax expert.

How Capital Gains Taxes Work in Real Estate

Although capital gains taxes apply to the sale of any asset, this article will focus exclusively on how they work for real estate. There are standard principles that apply to capital gains taxes in real estate. The sales price minus the cost basis, which includes the purchase price and cost of any improvements, will be used to determine the capital gain.

Primary Residence Exclusion:

As a real estate investor, you may consider selling your primary residence as you expand your portfolio and grow your wealth. Primary residencies can exclude a specific amount of capital gains under certain conditions. The primary residence exclusion is currently set at up to $25,000 for single owners and $500,000 for married couples who are filing jointly. 

A primary residence is one that the seller must have owned and lived in as a home for two or more years. It’s worth noting that capital losses from the sale of personal property, such as a primary residence, are not deductible from gains. 

Under the primary residence exclusion, a single taxpayer may purchase a home for $300,000 and later sell it for $600,000, making a $300,000 profit. The capital gains from this sale are calculated by accounting for the $250,000 exemption, setting the taxable capital gain at $50,000.

Depreciation Recapture:

Real estate investors can utilize depreciation recapture to reduce the amount of capital gains taxes they’re liable for. Depreciation recapture enables investors to make deductions against their income that reflect the deterioration of an investment property over time. A property may decline in its physical condition over time with the depreciation reducing the amount an investor is considered to have paid for the property.

While depreciation can lower your taxable income during ownership, depreciation recapture taxes may increase your taxable capital gain when you sell. Understanding this can help you prepare for future tax implications.

Other Taxes to Consider:

Capital gains taxes are not straightforward. State taxes may impact the capital gains you pay as some states operate their own taxation laws, including the ability to set a higher rate of capital gains tax. Certain high-income earners may also be liable for net investment income tax (NIIT), an additional 3.8% tax that applies to certain net investment incomes above the statutory threshold amount. 

Strategies to Minimize Capital Gains Taxes in Real Estate Investing

There are strategies real estate investors can use to minimize the capital gains taxes they’re liable for. Understanding how capital gains taxes work and accounting for them is a crucial part of any investing strategy. Correctly structuring your investments by accounting for the impact of capital gains taxes can reduce your liability and ensure you keep more of your profits.

Where possible, it’s recommended to hold your investment properties for at least one year to qualify for the lower rate of long-term capital gains tax. It’s also possible to minimize capital gains taxes by offering gains against losses from other investments to lower your tax liability. 

Here are two taxation policies you can utilize:

Qualified Opportunity Zones (QOZs):

Qualified Opportunity Zones (QOZs) offer real estate investors the opportunity to defer capital gains taxes by reinvesting profits into designated areas. This strategy can significantly reduce your tax burden while supporting growth in underdeveloped markets. This program gives investors 180 days from the realization of the gain, such as the closing date of the property sale, to invest in their chosen QOZ fund. These funds can provide deferrals and exclusions for capital gains. 

1031 Exchange:

Section 1031 of the Internal Revenue Code enables investors to defer the payment of capital gains taxes by reinvesting their capital into a property of a similar type. This mechanism provides investors with a way to defer capital gains taxes indefinitely if they continue to reinvest their profits into qualifying like-kind properties. An investor has 45 days from the sale of a property to identify their replacement property with a total of 180 days to complete the exchange. 

Impact of Capital Gains Taxes on Real Estate Investment Strategies

It’s important to consider the potential capital gains tax implications when choosing your investment strategies. Whether you’re investing in rental properties or fix-and-flip complexes, it’s crucial to consider their potential impact on capital gains taxes.

For investors focusing on long-term wealth accumulation, a buy-and-hold strategy offers the benefit of lower long-term capital gains tax rates, alongside appreciation in property value and rental income. This investment strategy is a long-term passive strategy that supports a stable portfolio, helping to minimize the impact of short-term fluctuations. Typically, a buy-and-hold strategy will also outperform rental properties that require active management. Investors who choose a buy-and-hold strategy can also utilize mechanisms to defer their capital gains taxes.

By comparison, a fix-and-flip strategy may leave you liable to pay the higher rate of short-term capital gains tax if the property is sold within a year. The purpose of a fix-and-flip strategy is for the investor to purchase a property at a lower price, conduct renovations, and quickly sell it again at a higher price. 

Depending on the profit margin of a fix-and-flip strategy, and your other investments, it may be sensible to wait for more than a year to benefit from the lower rate of long-term capital gains tax.

Capital Gains Tax Planning for Real Estate Investors

As a real estate investor, your accountant and tax advisor will be your best friends. Tax planning is crucial to maximizing the potential of your investment portfolio and minimizing your tax liability. Effective tax planning is essential for real estate investors to manage capital gains taxes. By working with tax professionals and planning for future tax liabilities, investors can avoid unexpected tax bills and make more informed decisions.

There are multiple ways to legally minimize your capital gains tax liability, from utilizing Section 1031 of the IRS code to using a retirement account to buy an investment property. 

Selecting the right year for the title and possession of an investment property to be passed onto a seller can help mitigate your tax burden. When this happens, it marks the year that the capital gains from the property transaction must be reported. Tax planning and forecasting can help investors determine the best year to sell a property for tax purposes.

Tax-loss harvesting is another method of tax planning used by investors when the gains from the sale of a rental property are offset against the loss of another investment. While this strategy is commonly used for stock investments, it can also be used by real estate investors. 

Similarly, real estate investors can choose to sell assets during a low-income year as capital gains taxes are set in relation to a taxpayer’s ordinary income tax. Capital gains taxes are not accessed separately, so a low-income year is an ideal time to sell an investment property compared to a high-income year.

Common Mistakes Real Estate Investors Make with Capital Gains Taxes

If you’re a first-time investor, there are common mistakes you want to avoid with capital gains tax. Real estate investors often overlook the impact of capital gains taxes when projecting potential profits. A comprehensive understanding of tax liability is essential for making profitable investment decisions.

Strategies like opportunity zones and 1031 exchanges can provide tax breaks to minimize your liability. While depreciation recapture can also lower your tax bill, it’s important to consider the potential impact this may have on your capital gains taxes in the future.

You can avoid making these common mistakes with capital gains taxes by working with a tax advisor or accountant. If you’re a first-time investor, an accountant or tax expert can provide crucial insights to ensure you’re not caught out by an unexpected tax bill.

How Recent Tax Law Changes Affect Real Estate Investors

Tax legislation is continuously changing on both a federal and state level. 2025 is set to mark a major year for potential tax law changes with the new presidential administration and sunset clauses in significant legislation, including the Tax Cuts and Jobs Act (TCJA).

The top individual tax bracket currently sits at 37%, but is scheduled to increase to 39.6% in 2026, returning to its pre-TCJA rate. This change will be significant for real estate investors with a higher overall tax liability, whether from investments or personal income.

Another significant change that could impact real estate investors is the state and local tax (SALT) deduction cap of $10,000, scheduled to be lifted in 2025. Lifting this deduction cap would be beneficial for real estate investors in high-tax states, such as New York. The removal of the cap would enable investors to utilize more deductions to offset their taxes.

Investors using opportunity zone investments to offset their taxes should be aware that deferred gains will become taxable from December 31^st, 2026. It’s crucial for investors to plan for this tax liability. These recent and upcoming tax law changes emphasize the importance of creating a tax strategy to maximize cash flow.