Is there a way to minimize capital gains tax when selling a house if I plan to use the profits to start a business or purchase another property?

I am about to sell a house that I am flipping in Washington and want to minimize capital gains tax. My plan is to reinvest the profits I receive from the sale of the house to either get a startup business loan or purchase another property to flip. Is there an account I can put the profits in so that I can keep investing it in my business and real estate without being charged capital gains tax on the profit? My line of business is construction.

Co-Published on Investopedia

Co-Published on Investopedia

If you live in the house as your primary residence, you will be able to take up to $250,000 as profit without paying any capital gains tax ($500,000 if you are married). This would be the ideal option but may not apply to you. If you don't live in the house as your primary residence, there are options to minimize capital gains taxes, but you will need to determine if you want to start a business or buy another rental house before you sell the current house.

Buying a New Property

If you decide to use the proceeds to purchase another investment property, you have the option of doing a 1031 Exchange. This allows you to defer taxes on the profits from the first house by reinvesting them into the new rental property, provided you follow some very stringent rules and the new property qualifies.

With a 1031 Exchange, you cannot deposit the money into an existing savings account or have access to the money in any way. Instead, a qualified 1031 intermediary will receive the funds from the sale of the first property and use the funds to purchase the new investment property. If you have access to the money from the sale of the first property, the 1031 Exchange falls apart and you will owe taxes on the gains. Even the option to deposit the funds into a savings account can blow up the 1031 exchange.

1031 Exchanges CAN'T be done on your own, and you must be working with a qualified intermediary before you sell the property. The IRS is very aggressive about the 1031 exchange rules. This article is a good example of the IRS threatening real estate investors who don't follow the 1031 exchange rules by the letter.

Starting the Business

If you want to start a business, your best bet is to just sell the property and pay the taxes. The good news is starting a business will unlock a lot of other tax advantages, so you may not notice the tax hit very much. A good CPA with a planning focus or comprehensive financial advisor can help you use the starting of your new business to significantly reduce your overall tax bill.

In fact, you may end up better off paying the taxes on the property verses avoiding the taxes with a 1031 Exchange. With proper financial planning, you could pay a low tax rate on the capital gains from the property; while at the same time using the new business to lower your higher-rate income taxes. Situations like this can be where a good financial planner will earn their fee many times over. (Of course, an advisor who focuses on investments may not be able to help).

Joshua Escalante Troesh is the President of Purposeful Strategic Partners and a tenured professor of Business at El Camino College. To explore working with him on your personal financial planning and investment advising needs, simply schedule a free Discover Meeting.

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