Georgia has been one of the most popular states for investors in recent years, and with it comes tax implications. Capital gains taxes are one of the biggest items that can erode your investment profits, so understanding how to minimize or even avoid them is key to maximizing your return on investment.
What Is Capital Gains Tax
So, what exactly is a capital gain? A capital gain occurs when you sell an asset—such as stocks, bonds, real estate, or even a business—for more than you paid for it. The difference between the sale price and your purchase cost is considered a gain, and the government imposes a tax on those gains to collect revenue from the investor. The reason for a government taxes gains is to generate revenue that can be used to finance public services.
How Is Capital Gains Tax Is Calculated In Georgia
Capital gains taxes can seriously impact your investment returns, which is why knowing how to avoid them in Georgia is essential. In Georgia, the capital gains tax rates vary from 1 to 5.75 percent, depending on the investor’s income level and the type of asset.
To give you a better idea of the specifics, according to the Georgia Department of Revenue (2021), if an investor has a yearly income below $2,000, they will be taxed at a rate of 1 percent. Investors with an income bracket of $2,001 to $7,000 are taxed at a rate of 3 percent, and those with an income above $7,001 are taxed at a rate of 5.75 percent.
Taxpayers who are married and filing their taxes jointly have the option to claim certain deductions. An example of this is that they can choose to file their taxes together and get a higher standard deduction.
Let’s explore some methods of avoiding capital gains taxes now that you understand what they are and how they operate in Georgia.
What Are Some Ways To Prevent Paying Capital Gains Tax On A Rental Property?
There are a few ways that investors can avoid capital gains tax on rental properties.
What is the 1031 Exchange
1031 Exchange: The most common and effective way to avoid paying capital gains tax on a rental property in Georgia is to utilize a 1031 exchange. This method allows investors to defer the taxes on the sale of one investment property by purchasing another investment property. Essentially, a 1031 exchange allows the investor to roll over their gains from the sale of one property into the purchase of another property, without recognizing the gain for tax purposes.
1031 Exchange Requirements In Georgia
To qualify for a 1031 exchange, the properties involved must be of similar, meaning they are of the same nature or character, such as two rental properties or two commercial buildings. Additionally, the investor must identify their replacement property within 45 days of the sale of the original property and complete the purchase of the replacement property within 180 days.
What Is Depreciation Deductions
Depreciation Deductions: Another way to reduce or avoid capital gains tax on rental property is through depreciation deductions. Depreciation is a tax deduction that allows you to recover the cost of the rental property over time. It is based on the idea that your rental property is losing value as it ages and experiences wear and tear.
In Georgia, residential rental property has a depreciation period of 27.5 years, while commercial rental property has a depreciation period of 39 years. This means that you can deduct a portion of the property’s value each year for that length of time.
For example, let’s say you purchased a rental property for $200,000. You could deduct the cost of the property over 27.5 years, or roughly $7,273 per year. This deduction will reduce your taxable income, and therefore reduce the amount of capital gains tax you owe when you sell the property.
Using Charitable Trusts To Avoid Capital Gains Tax In Georgia
Charitable Trusts: Finally, charitable trusts can also be an effective way to avoid capital gains tax on rental property. By donating rental property to a charitable trust, investors can receive a tax deduction for the fair market value of the property, which can help to offset any capital gains tax owed on the property. Additionally, if the rental property is sold by the trust, any gains are exempt from capital gains taxes.
Now that you know how to avoid capital gains taxes on rental property in Georgia, let’s look at some strategies for avoiding them when selling a house.
Avoiding Capital Gains Tax When Selling A House
There are various methods to minimize or eliminate capital gains tax when you sell your property.
Home Sale Exclusions
When it comes to avoiding capital gains tax on the sale of a house, the most effective strategy is to utilize the home sale exclusion. This allows you to exclude up to $250,000 of capital gains if you are a single taxpayer, or up to $500,000 if you are married filing jointly.
To qualify for the home sale exclusion, you must have owned and used the home as your primary residence for at least two out of the five years leading up to the date of sale. Additionally, you must not have used the exclusion for any other property in the two-year period prior to the sale of the current property.
It’s important to note that the home sale exclusion can only be used once every two years, so if you are considering selling multiple properties within a short time frame, you may want to consult with a tax professional to determine the best course of action.
Avoiding Property Gains Tax Through Home Improvements
Another important consideration when selling a house is the impact of home improvements on capital gains tax. Any improvements you make to the property can be added to the cost basis, which effectively reduces the amount of capital gains you will owe when you eventually sell the property.
For example, let’s say you purchased a home for $300,000 and then spent $50,000 on renovations. When you sell the home for $500,000, your gain would be $150,000 ($500,000 sale price minus the $300,000 cost basis). However, if you add the $50,000 renovation cost to the cost basis, your gain would be reduced to $100,000 ($500,000 sale price minus the $350,000 adjusted cost basis), resulting in a lower capital gains tax bill.
How To Use An Installment Sale To Avoid Property Gains Tax
Another way to avoid capital gains taxes on a home sale is to sell it as an installment sale. This option allows the seller to defer their capital gains tax by spreading it over multiple years, rather than being hit with a large tax bill all at once. Essentially, the seller agrees to receive payments over time, rather than a lump sum at closing.
In an installment sale, the seller acts as the lender, and the buyer makes payments to them over an agreed-upon period. The payments are made in installments, hence the name, and include both principal and interest. This option allows the seller to receive a steady stream of income over several years, while also minimizing the amount of capital gains tax they owe.
It is important to note that not all homes are eligible for installment sales. The property must be classified as investment property, rather than a primary residence, and the sale must be structured as an installment sale from the beginning. Additionally, the buyer and seller must come to an agreement on the terms of the sale, such as the length of the payment period and the interest rate.
One potential downside to an installment sale is that the seller may have to carry the mortgage for a longer period, which can be risky if the buyer defaults on their payments. However, there are ways to mitigate this risk, such as requiring a substantial down payment or setting up a balloon payment at the end of the payment period.
What Is A Qualified Opportunity Fund?
Finally, investors may also want to consider using a Qualified Opportunity Fund (QOF) when selling a house. A QOF is an investment vehicle that allows individuals and businesses to invest in certain types of projects located in qualified low-income communities. When an investor sells their property and invests the proceeds into a QOF, they can defer their capital gains tax until the end of the fund’s holding period—usually 10 years. In addition to offering deferral of capital gains taxes, some QOFs can actually provide other tax benefits as well. For example, some funds offer additional deductions on income derived from QOF investments, which can help offset any remaining taxes due at the end of the holding period.
To sum up, paying capital gains taxes can reduce your investment profits by a considerable amount. Knowing how to minimize or avoid them is key for maximizing profits in Georgia. There are a variety of methods you can use to reduce or eliminate the amount of capital gains tax you pay when selling an asset such as stocks, bonds, real estate, or even a business. These include 1031 exchanges and depreciation deductions for rental properties; home sale exclusions; installment sales; and Qualified Opportunity Funds (QOFs). Understanding these strategies will help ensure that you maximize your return on investment while minimizing the impact of capital gains taxes.