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One of the best ways to grow your money is to invest it in profit-generating assets. One very typical example of this is people buying properties, which they either lease or rent out. Thus, people are able to derive income beyond their salary, which — in an era when wage levels are struggling to keep up with the cost of living — has made investment a more popular option.
Other than the examples of rent or lease, one of the easiest ways to make a profit on an investment is by waiting for its value to appreciate, then selling it at a higher price than it was bought for. However, the drawback here is that the profit you make is now subject to a capital gains tax.
Because of capital gains tax, your decision to sell an asset may not prove to be so financially wise after all. To ensure you are getting your money’s worth, it is important to understand how capital gains tax works.
When is capital gains tax applied?
Capital gains tax applies to any form of assets that get sold, such as stocks, property, and equipment. From its name, the tax is levied on any capital gain, which is the resulting profit when the selling price is greater than the buying price.
It is computed as the difference between the two. Should the selling price be lower than the buying price, this will result in a capital loss, which can be used to offset any capital gains and reduce the total tax to be paid.
How do I minimize capital gains tax?
One way to minimize capital gains tax is by holding the asset for a long period of time before selling it. The rates on short term capital gains tax, which is applied when the asset is held for less than a year before being sold, are lower than long-term rates. Furthermore, long-term rates vary according to the profit made, meaning it is possible to have a 0% tax rate.
Can I legally not pay capital gains tax at all?
There is a way to save on paying capital gains tax, which is known as the 1031 tax exchange, or a like-kind exchange. Based on Section 1031 of the Tax Code, this allows individuals to sell a property and not incur a tax liability by availing another property of similar (“like-kind”) value.
This is strictly limited to business or investment properties only, meaning that exchanging primary residences will not qualify for the reduction in capital gains tax. Under regulations provided for, the investor has up to 45 calendar days after closing the sale on the property to identify the potential properties that he or she wishes to purchase.
The replacement property being bought should then be transferred to the investor at most 180 days after the original property has been sold. In order to qualify for a 1031 tax exchange, the property to be bought must be of the same or greater value than the amount that the original property was sold for.
Used properly, especially for properties that are then rented out, this can even increase the income being generated by the property, all while avoiding having to pay capital gains tax.
As with much else in life, investing your money is well worth it only if you know what you are doing. If you do your due diligence, you will be amazed at the opportunities for profit that you would never have imagined.