Strategies to Reduce Tax on Capital Gains from Property Sales

What are the best strategies to minimize capital gains tax on property sales?

Selling real estate triggers capital gains tax on the difference between your adjusted basis in the property and the sale price. That taxable gain can be reduced, deferred, or spread over time using several well-established strategies. The right choice depends on property type (primary residence, second home, rental, or business use), how long you’ve held the asset, prior depreciation taken, your income level, and state tax rules.

Below are practical, IRS‑recognized strategies I use with clients, how they work, when they are realistic, and implementation steps. Sources from the IRS and other authoritative resources are cited inline so you can follow up on rules and limits.

1) Use the primary residence exclusion when eligible

How it helps: Homeowners who meet ownership and use tests can exclude up to $250,000 of gain ($500,000 for married filing jointly) from taxable income on the sale of a primary residence. This often eliminates tax entirely on modest gains.

Key points:

• You must have owned and used the home as your main residence for at least two of the five years before the sale (IRS Publication 523) [https://www.irs.gov/publications/p523].
• The exclusion can generally be used only once every two years.

When to use: If the property is your primary home and you meet the tests, this is usually the simplest and most powerful tax-saver.

Implementation checklist:

• Confirm the 2‑of‑5 ownership/use test.
• Gather closing statements, utility bills, and other proof of residency.
• Subtract selling costs and add allowable adjustments to basis (improvements—see section on basis).

Source: IRS — Selling Your Home (Publication 523) [https://www.irs.gov/publications/p523].

2) Defer tax with a 1031 like‑kind exchange (investment property)

How it helps: A 1031 exchange under IRC §1031 lets owners of qualifying investment or business real estate defer recognition of gain when they reinvest proceeds into a “like‑kind” property. The gain — and associated tax — is deferred until the replacement property is sold without another qualifying exchange.

Key limits & rules:

• Only for investment or business properties, not for primary residences.
• Strict timelines: identify replacement property within 45 days and complete the exchange within 180 days (or by the tax return due date in some cases).
• Use a qualified intermediary to hold exchange funds; direct receipt of sale proceeds can disqualify the exchange.

When to use: If you plan to continue investing in real estate and want to preserve capital for a larger replacement purchase. It’s a common strategy for landlords and rental investors.

Implementation steps:

• Engage a reputable qualified intermediary early.
• Decide whether to pursue a full deferral (match value and debt) or take some cash out (“boot”), which may generate taxable gain.

Internal resources: See our detailed guide on 1031 exchanges and practical considerations: How to Use 1031 Exchanges in Personal Real Estate Strategies (FinHelp) [https://finhelp.io/glossary/how-to-use-1031-exchanges-in-personal-real-estate-strategies/] and the main 1031 Exchange overview [https://finhelp.io/glossary/1031-exchange/].

Authoritative source: IRS — Like‑Kind Exchanges Under Section 1031 [https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-under-section-1031].

3) Adjust basis with documented improvements and closing costs

How it helps: Increasing your property’s adjusted basis reduces the taxable gain. Capital improvements (not routine repairs) and certain closing costs add to your basis.

What counts:

• Capital improvements that add value, prolong useful life, or adapt property to new uses (e.g., room additions, new roof, major HVAC replacements).
• Selling expenses (real estate commissions, title fees) reduce the amount realized and lower the gain.

Practical tip: Keep receipts, contractor invoices, and dated permits. When in doubt, document and consult a CPA about whether a cost is capitalizable.

Reference: IRS Topic No. 701 and related publications on basis and improvements.

4) Watch depreciation recapture on rental and business property

How it helps (and hurts): Depreciation you previously claimed on rental or business property reduces your basis and creates ordinary‑rate recapture income on sale. For real property, the recapture rate can be up to 25% for Section 1250 depreciation adjustments.

What to do:

• Calculate depreciation taken over the holding period exactly; this amount is recaptured and taxed differently than capital gain.
• Use a 1031 exchange to defer both the gain and depreciation recapture when reinvesting in qualifying property.

Source: IRS guidance on depreciation recapture and Publication 544.

5) Spread the gain with an installment sale

How it helps: An installment sale lets you report gain as payments are received, spreading tax liability over several years and possibly keeping you in a lower tax bracket.

When it works best: When the buyer agrees to seller financing or structured payments, and the total gain is not all ordinary income (depreciation recapture still taxed in year of sale to the extent of prior depreciation). Not appropriate if buyer wants a clean, lump‑sum closing or if the seller needs all cash immediately.

Implementation tips:

• Use a written promissory note with clear payment schedule, interest rate, and default provisions.
• Work with tax counsel to prepare Form 6252 (Installment Sale Income) and understand state rules.

Reference: IRS Topic No. 701 and Form 6252 instructions.

6) Charitable strategies: donate or use a Charitable Remainder Trust (CRT)

How it helps: Donating the property outright to a public charity avoids capital gains tax and may provide a charitable deduction. A charitable remainder trust allows you to sell the property inside the trust (no immediate capital gains tax), receive income for life or term, and the remainder goes to charity — you get a partial income tax charitable deduction at funding.

When to use: If charitable giving is an objective and you don’t need all proceeds as cash immediately. CRTs require professional setup and ongoing administration.

Reference: IRS rules on charitable remainder trusts and charitable contributions.

7) Gifting, estate strategies, and step‑up in basis

How it helps: Gifting property to family before sale may shift tax to the recipient, but the donor retains the original basis for determining gain (so this often increases overall family tax). At death, heirs generally receive a step‑up in basis to fair market value, which can eliminate capital gains tax if the property is sold soon after inheritance.

Warning: Estate planning moves must be coordinated with estate tax rules, family goals, and potential gift tax consequences. Don’t gift to avoid tax without counsel.

Reference: IRS rules on basis at death and gift/estate tax.

8) Offset gains with losses and time the sale

How it helps: Sell other capital assets at a loss (tax‑loss harvesting) to offset gains from the property sale. Also, consider timing the sale for a year when your taxable income will be lower — long‑term capital gains rates are income‑based (typically 0%, 15%, or 20%), and the 3.8% Net Investment Income Tax (NIIT) can apply to high‑income taxpayers.

Practical guidance:

• Check expected income for the year, run projections with your tax advisor, and see if delaying a sale into a lower‑income year reduces tax.
• Use losses from other investments strategically; beware wash‑sale rules for securities.

Sources: IRS Topic No. 409 (Capital Gains and Losses) and IRS guidance on NIIT.

9) State tax planning

How it helps: State capital gains tax rules vary widely. Selling while a resident of a state with no income tax (or lower tax) may reduce overall tax, but changing residency has rules and timing implications.

Action steps:

• Check state residency rules, domicile tests, and exit dates.
• Consult state tax counsel before changing residency primarily to avoid tax.

Common mistakes I see in practice

• failing to track and document capital improvements and depreciation;
• assuming a primary residence exclusion applies when it doesn’t;
• trying a 1031 exchange without a qualified intermediary;
• not accounting for depreciation recapture; and
• overlooking state taxes.

Quick example (long‑term gain calculation):

• Purchase price: $300,000
• Capital improvements: $50,000
• Depreciation claimed (rental years): $30,000
• Adjusted basis = $300,000 + $50,000 − $30,000 = $320,000
• Sale price less selling costs = $400,000
• Realized gain = $400,000 − $320,000 = $80,000
• Portion attributable to prior depreciation ($30,000) may be subject to recapture (taxed up to 25%), and the remaining $50,000 generally qualifies as long‑term capital gain.

Next steps and how to choose a strategy

1. Classify the property (primary residence / second home / rental / business).
2. Calculate accurate adjusted basis and depreciation taken.
3. Project taxable income for the sale year (federal + state).
4. Evaluate options: primary residence exclusion, 1031 exchange, installment sale, CRT, or timing and loss harvesting.
5. Engage a CPA or tax attorney before executing complex transactions (1031, CRT, large installment sales).

Internal reading and tools

• How to Use 1031 Exchanges in Personal Real Estate Strategies (FinHelp) — a practical walk‑through and common pitfalls: https://finhelp.io/glossary/how-to-use-1031-exchanges-in-personal-real-estate-strategies/
• Calculating Basis and Capital Gain on Property Sales and Exchanges — step‑by‑step basis calculation and examples: https://finhelp.io/glossary/calculating-basis-and-capital-gain-on-property-sales-and-exchanges/

Authoritative sources for rules and limits

• IRS — Topic No. 409, Capital Gains and Losses: https://www.irs.gov/taxtopics/tc409
• IRS — Selling Your Home (Publication 523): https://www.irs.gov/publications/p523
• IRS — Like‑Kind Exchanges under Section 1031: https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-under-section-1031
• IRS — Net Investment Income Tax (NIIT): https://www.irs.gov/businesses/small-businesses-self-employed/net-investment-income-tax

Professional disclaimer
This article is educational and not individualized tax advice. Rules are complex and change; contact a qualified CPA or tax attorney to analyze your situation before executing any of these strategies.

If you’d like, I can prepare a short checklist tailored to a primary residence, rental property, or small business real estate sale — tell me which property type you want the checklist for.