Capital gains tax is one of the most significant considerations for investors considering selling their assets. Depending on the investor’s tax bracket and how long they held the asset, the capital gains tax can significantly reduce the realized profit from the sale of their investment.
Previously, taxpayers could benefit from a capital gains exemption for seniors.
Now, everyone will owe capital gains tax on the sale of capital assets. If you are nearing retirement age or considering how your investment strategy could change as you get older, understanding capital gains tax can help you create an investment strategy that minimizes your tax obligation.
This article will guide senior investors through strategies for managing capital gains taxes, with a focus on the Section 121 exclusion and 1031 exchanges.
What Are Capital Gains Taxes?
Capital gains are the profit earned from selling a capital asset—such as real estate, stocks, or other investments—for more than the adjusted purchase price. Capital gains taxes are the taxes owed on those profits.
The capital gains tax rates vary depending on how long the owner held the property. The Internal Revenue Service considers capital gain to be long-term if the investor holds the asset for longer than one year before selling it. Any capital gains made on the sale of an asset or property held for one year or less are short-term.
Long-term capital gains tax rates range from 0% to 20% of the realized profit from the sale, depending on income and how you file taxes. Short-term capital gains taxes range from 10% to 37%. A capital gains tax calculator can determine the amount of taxes investors owe on the sale of a real estate property. For most people, long-term capital gains are taxed at lower rates than ordinary income tax rates, so it’s smart to hold investments for over a year before selling.
Because real estate can tend to appreciate over time, capital gains from property sales are often substantial, making tax planning especially important.
Age and Capital Gains Taxes: Setting the Record Straight
At one time, there was an age-related capital gains tax exemption in effect, which allowed people over the age of 55 to exempt a certain amount of capital gains realized on the sale of their primary residence. This law was referred to as the over-55 home sale exemption. This capital gains tax exemption provided taxpayers some relief from the tax burden when they sold their homes. To qualify, the seller or one of the title holders had to be 55 on the day they sold their residence.
However, the passing of the Taxpayer Relief Act of 1997 abolished that exemption. Now, an investor’s age does not affect how much capital gains taxes they owe. Instead, the IRS bases capital gains tax rates on two main factors: how long the asset was held and the investor’s income level.
If you own a property for at least one year, you pay long-term capital gains taxes, which may be less than short-term capital gains taxes depending on your tax bracket. Some investors use capital losses, which occur when an asset is sold for less than its adjusted cost basis, to reduce their tax obligation further. Taxpayers can also reduce their tax burden by using capital loss—when an asset sells for less than its adjusted basis—to offset capital gains tax liability. They can claim a deduction on their taxes of the total net loss or $3,000, whichever is less. If the loss is more than $3,000, taxpayers can carry the loss into future years.
The Primary Residence Exclusion: Section 121
The over-55 home sale exemption has been replaced by a home sale exemption that can benefit taxpayers of any age. Section 121 of the Internal Revenue Code allows homeowners to exclude a portion of their capital gains from the sale of their primary residence. Homeowners who realize a capital gain on the sale of their primary residence might qualify to exclude up to $250,000 of that gain from their taxable income or $500,000 if they are married and filing jointly.
To qualify, homeowners must have lived in the home as their primary residence for at least two of the past five years. This provision is especially important for seniors who may have owned their homes for decades and seen substantial appreciation. As they downsize or relocate during retirement, the Section 121 exclusion can help minimize their tax burden, preserving more of their equity for retirement use.
Strategic 1031 Exchange Applications for Seniors
Even though there is no blanket tax exemption based on age, you can still leverage several strategies to minimize or defer tax liability.
Repositioning Assets
Seniors who sell their primary residence may be eligible for the Section 121 exclusion, allowing up to $500,000 in tax-free capital gains (for married couples filing jointly). Note that Section 121 exclusions apply to personal residences and therefore are not eligible for deferral under Section 1031, which is limited to investment or business-use real estate. However, seniors can still use their tax-free proceeds to invest in income-producing real estate, creating a new stream of passive retirement income.
For example, a senior couple sells their longtime home and qualifies for the full $500,000 capital gains exclusion under Section 121. They then use a portion of their tax-free proceeds to buy one or more rental properties via a direct purchase. These rental properties may now generate monthly income, supporting their retirement goals. Simultaneously, they downsize by purchasing a smaller personal residence with the remaining funds. If they later decide to sell those investment properties, they can explore strategies for avoiding capital gains tax by buying another property through a 1031 exchange.
Legacy Planning
Seniors can use 1031 exchanges to defer taxes on investment properties over many years and then pass those properties to heirs. When the owner passes, the property is transferred to heirs on a stepped-up basis. This means the property’s value is adjusted to its fair market value at the time of inheritance. The heirs may potentially eliminate any capital gains tax on the property’s prior appreciation if sold shortly after.
Key Considerations for Capital Gains Exemptions
It’s important to consider the complexity of the tax law of 1031 exchanges and Section 121. Investors who do not meet the criteria or deadlines will have to pay capital gains tax, and adhering to the IRC and navigating complex regulations is challenging for a single investor. It’s best to consult with qualified tax and legal professionals for personalized guidance.
Empowering Senior Investors with Real Estate Strategies
While investors can defer capital gains taxes, no capital gains tax exemptions specifically for seniors are available. Investors may still use various strategies to lower these taxes, such as:
- Holding a property for at least one year
- Offsetting capital gains with capital losses
- Performing a 1031 exchange
Wherever you are in your investment journey, 1031 Crowdfunding provides offerings to help you reach your financial goals. Registering for an investor account with 1031 Crowdfunding gives you access to our wide selection of vetted real estate properties for 1031 exchanges. To learn more, register for an account today.
This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC
