Other than getting tax-free money from your investment property, you have other things that you can do with the appreciated property. While the current tax law may change with the Trump administration, the long-term capital gains tax is still at 15 percent. This means that any property that has been held for more than a year will only be taxed at the capital gains rate instead of the higher income tax rate.
This essentially means that $100,000 in net profit will result in a $15,000 federal income tax. If you are like many property owners and have a higher tax bracket, you would normally pay $20,000 in income taxes on this property. If your state has a state income tax as well, then you would obviously need to take this into account.
Other than enjoying a reduced capital gains tax, your property appreciation can be used as leverage. You can basically make compound, tax-deferred growth that would be unavailable with other investments. By leveraging your current property, you can finance another investment property. For example, assume that your property appreciated by 20 percent in the last five years. While your house is worth more, the difference is not taxed until you sell it. In the interim, you can use that appreciation by refinancing with a bigger first mortgage or getting a second mortgage. The cash you receive from this refinancing can be used as a down payment on another investment property. Best of all, the cash you use as a down payment is tax free. Your interest payments on the refinance can also be deducted from your gross rental income when you file your taxes.
There are also other tax-deferred strategies that are available, but you will most likely need a qualified tax accountant to take advantage of them. With Section 1031 of the United States Internal Revenue Service Code (26 U.S.C.§ 1031), you can defer capital gains with your federal income taxes with certain kinds of properties. Meanwhile, an Installment Sale allows you to defer taxes as long as you receive at least one payment for the property a year after the original sale.
If you want to reduce your tax liability while your property appreciates, there are many options available. You can use the asset to leverage a new property purchase and reduce your capital gains tax. While some of these tax deductions are complex, they make it more lucrative to rent out a property instead of selling it.
