Transcription
Hey, guys. Toby Mathis here. And today we're going to go over a pretty interesting topic, which is how to pay 0% on capital gains when you sell a property. It's going to surprise some of you. But there's actually three ways, three ways where you can just avoid paying any sort of tax on this. There's two of them that are permanent. One of them that's going to require some elbow grease in the future. But let me go over these and then specifically, I'm going to talk about real estate.
So when I'm selling real estate and I don't want to pay any capital gains on it, we're not talking about recapture. We're not talking about some of these other secondary items, although it is possible to push those out, too. I'm going to specifically talk about capital gains and on a couple of different types of properties. So let's dive in.
Number one, when you own an investment property, you have the right to do what's called depreciation. Here's the funny thing is you may take depreciation, but you must recapture it when you sell. And this is not considered capital gain income. It's part of the gain, but it is recaptured on recaptured depreciation. And so what we're grabbing here is I took a deduction. Let's say that you bought a property. Let's say it's a single family home for $200,000 and your the land is $50,000. So you have $150,000 of depreciable basis for the structure and you're going to, you know, write that off over 27 and a half years. Or if you do a cost seg, you'll be five, seven, 15 and 27 and a half years of, you know what that is? The point is, is that you're taking a deduction as you go along because that property is going to have to be replaced every 27 and a half years. Right. Like the IRS says, it has a useful life and you get to take a deduction over it. So that's depreciation. The IRS says you can write that off and you can use that to offset any rents that you bring in, for example.
So we see this a lot of times when people have an investment property and they might use it as a vacation home periodically and they'll just be like, I'm not going to write it off. Well, here's the problem: you must recapture. So if you haven't been taking depreciation under those circumstances, you can be in for a nasty surprise. But that is not considered capital gains. What we're really looking at on capital gains is you think of selling your house, right? I wasn't using it as investment property. I don't have any recapture. It's the difference between my basis and what I sell it for. You can adjust that basis by adding improvements and things like that, but at the end of the day, I'm going to be paying something called capital gains, most likely long-term capital gains on that income.
And here's two options when you're doing that, when you sell your house. Number one is you have something called a 121 exclusion, which allows you to write off up to $250,000 of capital gains if you're single or $500,000 of capital gains if you're married. So it's this kind of cool thing where, hey, I can own a house or say I bought a house for $200,000 and and I'm living in it with my wife. And ten years later, we sell it for $400,000. We, or two years, could the last two years have been so crazy, but let's just say that typical and it's gone up in value. There's $200,000 again. When I sell, you know, subtract off some of the some of the costs and things like that. Maybe I have have improvements that I put on the house. But let's just say for sake of argument that we're talking about $200,000 of capital gains. I would pay zero tax on that ever. No recapture, no worrying about, hey, do I have to invest in another property or anything? No, that's just a stone cold. You don't have to pay any tax on it on your capital gains on that property, because there's an exclusion. And that exclusion says, I lived in it as my primary residence for two of the last five years. So 24 of the last 60 months I lived in it as my primary residence. It's in my name. It's my house, and voila, I magically get this big old exclusion that's called a 121 exclusion. And people are very aware of it. You know, nowadays, because the real estate agents are, hey, we've we've seen appreciation in real property like crazy. And so they all have to be pretty much up on this, otherwise they're going to the clients are going to be impossibly surprised to pay tax on something that they wouldn't. Almost all accountants know that this is out there. It's not a it's not a hidden code provision. But you will still want to make sure that you're taking it. And so, hey, I never have to pay tax on that. It doesn't matter whether I go buy another property, it just means I never have to pay tax on it.
The other way you never have to pay tax on it is, let's say, similar situation except instead of a whole bunch of gain. Maybe I'm a retiree and I sell my house. I bought it for $200,000. I bought it for $150. Now it's adjusted basis. After years of doing some improvements and things like that on the property, let's just say that I have $50,000 gain and I'm a retiree and a husband and wife and they're making $40,000 a year. That $50,000 on top of it is going to more than likely be taxed at zero because the long-term capital gains rates have a 0% category, up to about $90 grand. You have to look at your tax rates every year and you look at it and you say, all right, there's my long-term capital gains rates and I'm falling below that. You get your standard deduction, everything else, and you look at it going, wait a second, I am in the 0% long-term capital gains bracket. I do not have to pay any tax on that. You'll never have to pay a tax on that. And that's fantastic. So that is way number two. So we had the 121 exclusion and we have, hey, if it's low enough, it's going to be taxed at zero anyway.
And I get into arguments with accountants all day long on this stuff year after year because I look at people and they might be making $30, $40, $50, $60,000 a year and they have unrealized long-term gains in the stock market. And I'm yelling at them, sell that. Get up to the point where it's still 0% tax bracket. You know, so maybe sell $20,000 of your stock and reset the basis and buy it right back. And their accountants lose their mind and they say something like the wash sale rule. And I'm like, No, that's the wash sale loss rule. You can do this on gain and there's no reason not to. It's recognizing gain when you're when your tax is zero. Or let's say that you have a business. Let's say that we're in a a bad year and in a business where you're kicking down ordinary loss or you love investing in oil and gas and you get your income down to the nub, you could sell property and have capital gains and not pay any tax on it. And a lot of times people don't realize that if you're one of those people that gets yourself down to the 0% tax bracket, I'm just telling you, it's okay to have $90,000 around a $90 grand where the long-term capital gains, if you're married, cut that in half. If you're single. But you could have that and you're going to pay a 0% tax on it. So, yes, you could have income and still be at zero if it's capital gains. And by the way, things like dividends on qualified companies, qualified dividends, they are also taxed as long-term capital gains. So they're at zero. So I always look at those folks and I'm like, oh my gosh, bless it. Like there's there's so much cool stuff here. There's a 0% bracket and you'll never have to worry about doing anything. You don't have to reinvest it. You don't have to do anything. You just get free money. It's non-tax money. So you have 0% capital gains on your real estate. You never have to worry about it ever again.
Now, the third way is the most common one that you hear about, and that's by buying more real estate. It's called a 1031 exchange, and it's only real estate. Now, can we do this with there's no other types of assets, but if you sell an investment property and you buy more investment property and there are some rules on this, there's a time frame, 180 days, you have to identify replacement properties. You can you can do multiple properties, but not more than 200% of the value of the house of you letting go. Like, there's there's there's some rules that you have to follow. But here's the gist. You don't have to pay tax on it. You don't have to pay tax on the capital gains, nor do you have to pay tax on the recapture. So two things are actually pretty big.
So, you know, go back to the situation where you have a primary residence that you lived in two of the last five years. But let's say that you rented it for one year before you sold it. Well, now you're going to have depreciation recapture. If you want to avoid it, you're going to have to actually marry the 121 with the 1031 exchange, which you can do. The IRS tells us exactly how to do it, steps up the basis for that capital gain exclusion, and then you can offset and avoid having recapture on the depreciation, which might be a good idea, especially if you did a cost seg and you used it to offset other other passive income on something else if you're doing investments. But it's a fantastic tool to avoid the payment of tax. So that 1031 exchange becomes your friend if you're a real estate investor. And all I have to do is keep buying more real estate of equal or greater value. I can't have, but I can't get a bunch of cash when I buy these properties. So I can't just go out and create a situation where I'm walking over a bunch of cash and not pay tax on it. I'm investing the money and I'm putting it into real estate and I'm going to continue to buy more real estate.
And the really cool part here is that at the end of the day, as long as you do not sell in a taxable transaction, any of those properties. So as long as you're always 1031, eventually you pass away, your basis on those properties steps up to the fair market value on the day that you passed away. What does that mean? It means that for tax purposes, your basis is now the fair market value of the day that you passed, which means if your heirs sell it, they pay no tax because it's that same value. So what happened to all the capital gains and the depreciation you've been rolling forward? So, you know, 30 years ago I bought my first property at $200 grand and it went up to four. I bought a couple more. Those went up to $300,000 each. I sold those and bought five properties. Those went up to $400,000 each. And I had a $2 million portfolio. I sold those and bought some more. And now I have this portfolio of two and a half million dollars and I've never paid tax on any of the gain. And all I do is I pass away. And now if my heirs sell that two and a half million dollars for the property, you know what? My taxes or their taxes? Zero, right? I've never have to pay tax on that.
So I just showed you three ways that you could never pay capital gains on real estate. I know there's tons of other cool things that the tax code gives us, but those are the three big main ones that I wanted to point out. And if you're catching that bug and realizing, wait a second, there's lots of cool stuff in the tax code, I want to learn more. Don't worry, I got you covered. Just like it. Subscribe this channel. I'm always putting out content like this and if you think that this would benefit anybody else, by all means share it. And then, even more importantly, if you want me to cover other topics, put them down in the in the comments. I'll read them. And if it looks cool, I'll cut a video on whatever the topic is you are you designate. Thanks, guys.