Imagine deciding to sell your vacation home, rental property, or raw land. You sign a contract with a real estate agent, receive an offer, and just as you’re about to close, you realize you’ll owe a hefty capital gains tax on the proceeds.
Unfortunately, this is the harsh reality many people face when attempting to sell real estate that they’ve either inherited or owned for decades. Given the current real estate climate, values are soaring. However, instead of being able to cash in on all the profit, owners are facing sizable capital gains taxes.
The good news is, as a property owner, you have options. In this article, we’ll dive into what a capital gains tax is, how it works for real estate, and most importantly, how you can avoid them altogether.
A capital gains tax is a fee individuals are required to pay on the profit they receive when selling any investment – whether it’s stocks, bonds, jewelry, or real estate that isn’t their primary residence.
In general, there are two types of capital gains taxes. The first is a short-term capital gains tax levied on assets that were purchased and sold within the same year. Because these are considered speculative investments, the tax rate for these is usually the highest.
The second type is a long-term capital gains tax, which is owed when an asset sells more than a year after it was initially purchased. While a long-term capital gains tax rate is lower, it can still place a significant burden on your finances depending on the ultimate sales price of the asset.
A capital gain occurs when you sell a piece of property, whether residential, commercial, or industrial, for more than its initial purchase price. The tax is then applied to that amount depending on your tax bracket.
For example, let’s say you bought your first rental property in 1980 for $100,000, and today it is valued at $1,000,000. Assuming it will cost $20,000 to sell the property, your capital gains will be the $880,000 difference, which will incur a tax that is owed at both the state and federal income levels.
There are many ways to defer or postpone paying a capital gains tax, such as doing a 1031 exchange or trading the property for another. However, the best and only way you can completely avoid paying a capital gains tax is by donating your investment or inherited property to charity.
By donating real estate to charity, you become capital gains tax-exempt and also become eligible for other tax deductions. This can be a huge relief, especially for those who no longer want to handle the upkeep of a property and don’t want to get punished for selling it either.
The specific amount you can receive as a tax deduction when donating property will vary, depending on your adjusted gross income and other personal financial information. Typically, the IRS will cap the deductions you can take for charitable giving to a certain percentage of your income and require anything leftover to be used in the next five tax years
To illustrate, Susan decides to donate her $300,000 rental property. It’s run down, the tenants are not paying rent, and she’s facing a fine from the city for overgrown weeds. She has a tax basis of $100,000, and her deduction for charitable giving is capped at 30% of her income each year. By donating the property to charity instead of selling it, she avoids paying a capital gains tax on the $200,000 profit. Susan can additionally take $30,000 in deductions for the next five years for a total of $150,000 in tax savings.
Furthermore, because Susan has given the property to charity, she doesn’t have to worry about fixing it up, taking the tenants to court, or dealing with the day-to-day upkeep of the place. As you can see, the benefits of donating real estate to a charity of your choice become very clear.
Any property can qualify for a real estate donation (except timeshares and mobile homes). You can donate land, a single-family residence, an apartment building, an old commercial building, or even a warehouse. To maximize all the tax benefits, it's best to own the property for at least a year (even if you’ve inherited it).
You’ll also want to ensure your income is not so high that you’re unable to use up your entire tax deduction.
If you’re interested in exploring the option of donating a property to charity, you’ll have to take specific steps to make sure the organization you choose can accept your donation. The IRS generally requires a nonprofit to be formally organized as a 501(c)(3) and in good standing to be eligible to accept property donations.
Giving Property has partnered with dozens of nonprofit organizations across the country, matching donors with causes that resonate with them and helping them execute the donation properly to take advantage of all its benefits.
This was the case for a gentleman who inherited an automotive shop from his dad. Because he lived out of state and wouldn’t be able to facilitate selling the property on his own, he approached us. We were quickly able to sell the property and, more importantly, direct the proceeds to his father’s favorite public radio station, Michigan Radio.
For more information on donating your property to charity, contact us at 844-277-HOME or by visiting or filling out our form