Some real estate investors may have a rare and potentially time-sensitive opportunity to reduce or eliminate the capital gains tax from selling their real estate.

 

WHY?

Real estate values remain very high right now, and the stock and bond markets also grew incredibly since the financial crisis of 2008/2009. 

However, as of early May 2022, both the stock and bond markets declined 10-15% year to date. It is very rare for both stocks and bonds to be down like this when we simultaneously have a strong economy and housing market.

Investors with large balances in taxable investment accounts can “harvest” losses (carefully!) and then use those losses to offset the sale of real estate later this year. 

Step One:

Review taxable accounts. 

Since the stock and bond markets are down so far this year, see if any investments have unrealized losses.  Look for holdings with a negative cost basis. If you or one of your clients own individual stocks, some of them may have even larger unrealized losses than the broader markets.

Step Two:

In consultation with a skilled financial planner, sell the positions that have losses and immediately replace them with similar investments that also meet your goals. Ideally, do not just sit in cash for a month; work to keep your asset allocation the same.

You cannot replace the investment with the same or substantially identical investment for at least 30 days before or after the sale. Charles Schwab has a detailed explanation for how to avoid the wash sale rule. 

This process creates a loss that can be offset by a gain in another investment. 

Step Three:

Use your harvested losses to sell appreciated real estate.

Let’s say you or one of your real estate clients has a large taxable brokerage account and real estate subject to a capital gain. 

While a 1031 exchange is a common vehicle for investors to sell real property, the strategy outlined here is time sensitive and can give the investor cash in the bank this year.

Tax-loss harvesting is possible anytime an investor has an investment with a loss; there are just many more opportunties to employ this strategy during broad market downturns like we have now. 

Realtors® are well aware of increased property tax rates and how real estate investors may be considering selling their properties but wary of the capital gains impact when they do so.

If you have a potential listing from an investor client or a client with a gain in their personal residence of more than the exclusion limits (typically $500,000 for couples / $250,000 for individuals), ask them if they also have any taxable investments that could offset the real estate gain. 

Here’s an example:

The broad stock and bond markets are down 10-15% this year. An example client has a taxable portfolio of $500,000 that is down ~10% this year. They could potentially generate a capital loss of $50,000 through careful tax-loss harvesting. This is an estimate and depends on the actual investments in the account.

Then, imagine your example client also has a rental property or a highly appreciated primary residence that will be subject to capital gains tax when sold. 

If you don’t want to or can’t do a 1031 exchange for whatever reason, you can sell that property and offset the gain by the loss you generated in your taxable brokerage account. 

Capital gains tax brackets for most people are either 15% or 20% based on your income, so in this example, if you are able to offset a $50,000 gain with a harvested loss, you may have saved yourself $7,500-$10,000 in capital gains taxes.

Finally:

Why are the stock and bond markets down anyway and will this market environment persist?

No one can predict the long-term future of markets, and that goes for stocks, bonds, and yes, even local real estate! 

Also, despite current market conditions, we still advocate for efficient and low-cost exposure to stocks and bonds as a portion of many (but not all!) client portfolios.

Here’s what we do know:

The global economy is experiencing major changes in supply chains, labor markets, and inflation all at once. Transitory periods generally produce short-term volatility but go in cycles and do not last for a long time.  

Next Steps!

Some people may have the opportunity to offset some or all of the capital gains in their rental property or personal residence if they also employ “tax loss harvesting” within a taxable brokerage account. 

Need more details? Bankrate.com has a detailed summary here.

If you have a client that is on the fence about selling an appreciated property, ask them if they have other investments potentially eligible for tax-loss harvesting.

If you need help implementing this strategy, call us, your client’s financial advisor, or reach out to a fee-only advisor from XY Planning Network or NAPFA.

Disclosures: Past performance is no guarantee of future results. Fiduciary Financial Planning Group LLC DBA Real Estate Wealth Planning is an Investment Adviser registered with the State of Texas. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned.