- Capital gains tax is applied when you sell land that you profit on. The capital gains tax is only applied to the profits and not the total value of the land itself.
- Capital gains taxes are calculated based on your income bracket and the length of your property holding. Higher-income brackets have to pay more - whereas longer property holdings that exceed one year, pay less.
- You can lower capital gains or avoid them completely by using a 1031 Exchange, offsetting the capital gains with losses, donating to charity, or deferring the sale.
Making sure that you have your taxes in order when selling land is imperative, but the process for doing so can vary depending on the conditions of the sale.
The tax that you pay when selling land is called capital gains tax, which requires you to pay tax on the profit margins of the land transaction. The amount of tax that you pay will vary depending on your income bracket and whether it is a short-term or long-term holding.
After extensively researching IRS laws and regulations, I have gathered enough information to determine which taxes you have to pay when selling land. My research has indicated that landowners should carefully consider how much they have profited on their property when calculating capital gains tax to avoid legal issues with the IRS.
Table of Contents
What is Capital Gains Tax?
The taxman is always out to get you, even when it involves selling your own land. This is known as capital gains tax (CGT) and you can expect to pay it in most cases when selling real estate.
Capital gains tax is what you pay when you profit on land that you sell. It’s important to understand that capital gains tax is not applied to the overall value of the real estate that you are selling and only to the profit margin.
Depending on where you live, your capital gains tax can potentially be included as part of your income. This can become problematic for people that want to stay under a certain income bracket, as this can amount to paying a lot more tax in a fiscal year.
What Qualifies as Capital Gains Tax?
Capital gains tax is applied to virtually any asset that you sell - including land. This puts a lot of different things under the capital gains tax umbrella, which is why you want to be thorough and calculated when filing.
It’s easy to overlook certain assets that qualify as capital gains tax such as stocks and bonds. However, when it comes to real estate, you should make sure to keep the following in mind:
- Permanent Structures
In addition, this applies to the physical land itself. Land appreciates over time and you need to keep a record of how much you paid for the property, as well as any assets that are connected to it. Over time, these assets will likely appreciate - resulting in capital gains tax when you decide to sell.
How is Capital Gains Tax Calculated?
Capital gains tax is calculated based on the amount of money that you profited from your land. You do not have to pay capital gains if you did not profit from the real estate transaction.
This means that if you buy a piece of real estate at $100,000 and sell it for the same price, your capital gains tax will be zero. Whereas selling the same property for $150,000 will imply that $50,000 will be taxed under capital gains.
When you sell a property, you need to declare the land sale to the IRS. The IRS will review the transaction and expect you to pay the correct capital gains based on how much you profited. However, capital gains taxes can vary depending on a number of different factors.
Capital Gains Tax Based on Income
Filing taxes is never a pleasant experience - especially when you have to hand over part of your profits to the government. With that said, capital gains tax is not the same for all households and individuals.
This is particularly good news for people who do not breach a certain income threshold, as you may have very little capital gains tax, or none at all.
Keep in mind that tax rates are updated annually and you need to exercise due diligence to confirm that you are filing under the correct guidelines. This is a breakdown of how much capital gains tax you will have to pay for the 2023 tax year.
If you earn less than $41,675 as a single-person household, then your capital gains tax is 0%. Naturally, the tax rate climbs considerably the higher your income.
What you want to be aware of is how your state calculates capital gains. Each state has different guidelines for capital gains and some include this as part of your income. More on this later.
Long-Term vs Short-Term Land Holding
In addition to income, the amount of tax that you pay for capital gains can vary depending on how long you have held the property. The people that benefit from this the most are landowners that have held onto their property for a long time.
If you bought your property years or even decades ago, you can expect to pay less capital gains.On the other hand, real estate investors that are into ‘flipping’, will be at a disadvantage.
Landowners who purchase a property and then try to sell it shortly after will have to pay an increased tax rate on their capital gains. These are the capital gains rates for long-term vs short-term land holdings:
- Long-Term Land Holding (12 months+): 0% to 20%
- Short-Term Landing Holding (Less than 12 months): 10% to 37%
How to Avoid Capital Gains Tax
Taxes are never fun to deal with, which is why a lot of landowners often try to utilize strategies to avoid paying capital gains tax on their real estate transactions. The good news is that there are a number of tactics in the tax code that smart investors and landowners can take advantage of.
To make these strategies effective and legal, you need to make sure that you are following the guidelines carefully. Let’s take a closer look at how you can avoid paying capital gains tax on your land sale.
One of the best ways to avoid capital gains tax on a land sale is a 1031 Exchange. This is essentially a tax break that allows you to defer recognition of capital gains by reinvesting into similar assets.
Landowners who want to avoid paying capital gains can take the money that they earned from selling the property to buy new real estate. By doing so, they can avoid capital gains taxes altogether or pay considerably less.
Real estate investors particularly benefit from this, as they are in the business of actively buying and selling land. However, the 1031 Exchange has very specific guidelines that require you to find a replacement property within 45 days after the initial transaction - with 180 days to finalize the sale.
Offset Capital Gains With Losses
If you have losses as well as gains in your investments, you can use this to offset the capital gains that you would have to pay on your land sale. The way this works is that you essentially calculate how much you have lost financially with your other investments and subtract them from the capital gains.
This can get a bit complicated given that there are specific guidelines that differentiate short-term and long-term loss/gains. But overall, this is a great strategy to save on capital gains tax.
Donate to Charity
Not all landowners rely on their real state profits for income. If you are in a position to donate your appreciated land to charity, you can use this as a strategy to avoid paying capital gains.
There are some limitations to this based on your total gross income, but overall - you can use this as a method to save on your annual taxes.
A deferred sale is when you push back the official sell date of the land to a later period. This is only going to be strategic for certain businesses, corporations, and individuals that have fluctuating annual incomes.
A deferred sale becomes beneficial when you choose to file your capital gains in a year when you made less income. This allows you to strategize your capital gains payments by deferring them to a year when you will be under a specific income bracket - resulting in less taxes.
Which States Have the Lowest Capital Gains Tax?
Living in each state comes with its own set of advantages and disadvantages. One of the key factors that often sways a lot of people’s decisions when relocating is the taxes involved in living in that state.
Some people avoid heavy taxes like the plague and prefer to live where the government is not reaching into their pockets. Certain states in particular have very high tax rates and include capital gains as part of income.
If you want to avoid capital gains tax, you should consider buying and selling real estate in a location that has reasonable rates. With that said, some states do not have any capital gains tax at all such as:
- New Hampshire
- South Dakota
Residents living in these states do not need to pay capital gains tax at all when selling land. This offers investors huge incentives to pursue real estate transactions in these states.
Tips to Lower Capital Gains Tax
Paying capital gains tax can be unavoidable in many situations. However, the amount that you have to pay can greatly vary depending on how you file and approach your land transaction.
First and foremost, being aware of your finances and property information will be key to avoiding high capital gains. With that said, you can use the following tips to lower your capital gains tax when selling land.
Use a Capital Gains Tax Calculator
Filing your taxes on your own comes with a lot of responsibility and you want to make sure that you cross your t’s and dot your i’s when doing so. Naturally, keeping a detailed record of your finances and property info will be essential.
Once you have all of these figures, you can use a capital gains calculator. All you need to do is insert the appropriate figures and the calculator does the rest. This ensures that you get a general idea of how much you have to pay.
Ask a Financial Advisor
Understanding taxes and finances can seem overwhelming. And if you have a complex financial situation, one of the best ways to avoid making mistakes and paying more is to rely on a professional for assistance.
Financial advisors are great for keeping track of your income, taxes, and assets. If you do not feel confident about handling your capital gains taxes personally, let a professional take care of it for you. Although financial advisors are not free, they may potentially save you a lot more than what you spend for their services.
About THE AUTHOR
Brittany has been in the land business since 2020 when the world was starting to shut down. Since then, we’ve sold to dozens of people from ATV weekend warriors to camping enthusiasts to retired truck drivers. Our inventory spans mostly in the western United States. We’ve been trained by experience, land acquisition courses, and hundreds of hours meeting with county assessors and clerks, zoning officials, realtors, and land investors. We’ve answered hundreds of questions from people regarding the buying and use of land.Read More About Brittany Melling