What are Capital Gains on Investment Property?

Larry Ray Palmer

"Capital gains" is a term used to describe money made by purchasing something at a low price and then selling it for profit. In terms of investment property, such as rental houses or commercial buildings, the term "capital gains" refers to the profit made from selling these investment properties. Any capital gains on investment property can result in property investment tax issues for the seller, because they might be subject to taxation under local or national tax laws. For this reason, individuals who choose to invest in property are strongly encouraged to check their local tax laws to ensure compliance with the law.

Capital gains may refer to profit made from selling rental homes.
Capital gains may refer to profit made from selling rental homes.

The concept of a capital gains tax system was designed with the purpose of helping entrepreneurs and investors. In theory, the capital gains tax system provides incentives for investors to purchase properties and other investments with the knowledge that any losses that might be incurred can be spread out over the next year to reduce tax obligations. Even so, being assessed a tax for capital gains on investment property can be disheartening to a successful seller.

In some cases, a property owner can earn an exemption from taxes of capital gains on investment property. One of the most common ways to avoid paying tax for capital gains on investment properties is to invoke a primary residence clause, where one is available. If the owner of the investment property lives in the home for a period of one year, he or she might be able to claim it as their primary residence and would be exempt from paying any capital gains tax on the property.

There typically are other ways to earn an exemption from paying a portion of the taxes for capital gains on investment property as well. A capital gains tax is often applied only to profits made in the year of the sale, so with owner financing — an arrangement under which the buyer makes payments for the property directly to the owner in regular installments — the profits can be spread out over a period of several years, thus limiting the amount of capital gains tax that can be assessed to the seller. If the seller has had capital losses, money spent on repairs or investment property that sold at a loss, this often can be used to eliminate a portion of the capital gains tax debt. These capital losses often can even be carried over from previous years if they have not already been claimed. This exemption typically applies only to losses sustained on investment property and cannot be claimed for personal property losses.

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