*** Update 9-24-2024
Understanding capital gains taxes in Texas is crucial for anyone involved in buying and selling of real estate or any form of investments, whether they be in assets like stocks, bonds, or a Texas house. While federal capital gains tax rates and rules apply uniformly in other states across the United States, each state has its own set of rules and regulations.
Texas leaps out as special because of its unique approach to the state tax system and focus on tax burden reduction for Texans, particularly the long-term capital gains rate. As licensed real estate agents and realtors in Texas, we are profoundly interested in helping our partners (and readers here) optimize and maximize their hard earned profits. To do so, it all starts with understanding the tax code and how to reduce your long-term tax liabilities.
This guide will break down everything you need to know about capital gains tax in the state of Texas and the Federal level.
Understanding Capital Gains Tax on Real Estate and Other Investments
Through our extensive experience with real estate investments in Texas, we’ve guided countless clients through capital gains strategies. In simple terms, a capital gain is the profit you make when selling an asset—whether it’s a rental property, a multi-family building, or even stocks and bonds—at a higher price than what you initially paid.
The key distinction between ‘realized‘ and ‘unrealized‘ gains is critical. A capital gain only becomes taxable when you sell the asset, which is why timing your sale strategically can make a huge difference in your tax liability. For instance, if you’re planning to sell a rental property, waiting to hit the one-year mark could lower your tax rate due to long-term capital gains rules. The IRS details these distinctions in Publication 550: Investment Income and Expenses.
.
Types of Capital Gains Tax in Texas
Short-Term Capital Gains Tax
In our experience in Texas real estate investing, many real estate investors aim to hold properties for at least one year to take advantage of the much more favorable long-term capital gains tax rates. Short-term capital gains are taxed as ordinary income, which can significantly impact your bottom line. We’ve seen property investors miss out on material tax savings by selling properties too quickly, unaware of the tax ramifications. It’s crucial to understand this distinction and factor it into your investment strategy planning.
Long-Term Capital Gains Tax
Long-term capital gains are profits from the sale of an asset held for more than one year. These gains are taxed at lower rates than short-term gains, which can be 0%, 15%, or 20%, depending on your income level. The special tax treatment of long-term capital gains is designed to encourage long-term planning and have real estate investors stick around for at least a year before any property sales.
Understanding Capital Gains Tax in Texas
No Income Tax In State Of Texas: A Gamer Changer for Investors
Having personally been involved in over 2,500 real estate transactions throughout Texas, one of the key advantages we’ve seen firsthand is the lack of state income taxes or capital gains taxes. This pro-investment government policy allows real estate investors and homeowners to keep more of their hard earned profits, which can make a significant difference in your net returns.
According to the Texas Comptroller’s Office, Texas has no personal income tax, meaning that any capital gains from the sale of your property or other investments are only subject to federal taxes. In other states, such as California, investors can face an incredible combined tax rates as high as 37.3% (federal and state taxes combined). In Texas, you’re looking at just the federal tax as your responsibility. This substantial tax reduction and savings is one of the reasons we’ve seen a surge in interest from out-of-state investors from California, New York, Illinois and other high tax jurisdictions..
Comparison with Other High Tax States
In contrast, many states with high state income taxes also impose substantial capital gain tax. For example, California taxes capital gains at the same rates as ordinary income, with rates as high as 13.3%. New York also taxes capital gains as ordinary income, with rates up to 8.82%. The lack of a state capital gains tax in Texas makes it an attractive location for not only real estate investors and property owners, but investors of all kinds.
There are eight states that do not impose state-level capital gains taxes: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming.
On the flip side are the states with the highest capital tax rates, with some examples including very large population states of California (with a maximum 13.3% state capital gains tax), New Jersey (10.75%), Oregon (9.9%), and Minnesota (9.85%).
State Tax Implications for Texas Residents
The absence of a state income tax in Texas has several implications for residents:
- Increased After-Tax Returns: Without state capital gains taxes in the state of Texas, investors can retain more of their profits with this favorable tax code, resulting in higher after tax returns.
- Attraction for Investors: The tax-friendly environment makes Texas an appealing place for investors, potentially boosting local real estate and investment markets.
- Simplified Tax Filing: Without the need to account for state income tax, your personal income tax filing is only beholden to the Internal Revenue Service at the federal level of government. From the view of your Texas tax bill, it is a simplified process for Texas residents.
- Texas does not have an estate tax or inheritance tax.
- Sales Tax: Texas raises revenues through property tax and state sales tax. The current 2024 state sales tax rate is 6.25%.
- Property Tax: while offering a low income tax bracket for many, Texans should plan carefully when factoring in property tax which run higher in the state of Texas on a percentage cost basis as compared to the national averages.
In our experience at Bright Bid Homes with over 2500 real estate transactions from Dallas to Fort Worth, we have executed in the state of Texas, we have seen with our own eyes how much the advantaged tax implications in the state of Texas has brought tremendous economic investment from numerous out of state investors and a wide spectrum of new residents moving from California, New York, Illinois, and other high tax states.
We have partnered with real estate investors and new residents especially from the west coast states of California and Oregon who have established residency here in the state of Texas solely because of the lower tax rate burden. Of interest, the cities of Plano, Frisco, McKinney, and Allen are the favorite Texas destinations for former California residents with some interest in Arlington and Grapevine.
Our experience expands beyond just low tax investments but ranges to help real estate investors find fire damaged houses, rental property, navigate the FHA flip rule, selling an inherited property, finding a contractor to replace a leaking old roof, or getting a seller credit for repairs on an upcoming property sale or acquisition. With the low capital gains tax in the state of Texas, the real estate and overall level of investment interest will remain high and substantial.
Capital Gains Tax Strategy for Texas Real Estate Sales
Do you pay capital gains when you sell a house?
As a team who’s helped both long-time Texas residents and new investors navigate the complexities of property sales, we can tell you that understanding the rules around capital gains on real estate is critical. If you’re selling your primary residence, the IRS allows you to exclude up to $250,000 in capital gains if you file as a single individual, or up to $500,000 if you’re married and filing jointly (IRS Publication 523: Selling Your Home).
To qualify for this exclusion, you need to have lived in the home for at least two of the last five years before selling. I’ve seen clients increase their exclusions by planning well in advance and ensuring that they meet the IRS guidelines—particularly in today’s real estate market where home values have risen sharply. If you’re unsure about your eligibility or how depreciation recapture applies to investment properties, a conversation with a certified tax advisor can be invaluable
Investments That Are Not Real Estate
For stocks, bonds, mutual funds, and other investments, the treatment of capital gains is straightforward:
- Holding Period: Ensure you hold investments for more than one year to benefit from the lower long-term Texas capital gains tax rates.
- Qualified Dividends: Dividend tax due that qualify for long-term Texas capital gains tax rates can provide additional tax savings.
Retirement Accounts
Capital gains within retirement accounts like IRAs and 401k accounts are treated differently:
- Tax Deferral: Investments within these accounts grow tax-deferred, meaning you don’t pay taxes on gains until you withdraw the money.
- Roth Accounts: Contributions to Roth IRAs or Roth 401k accounts are made with after-tax dollars, but withdrawals, including capital gains, are tax-free in retirement.
Strategies for Managing Capital Gains in Texas
Timing Your Asset Sales for Optimal Tax Savings
One of the most effective ways to manage your capital gains tax liability is by carefully timing the sale of your assets. In my own experience, coordinating end-of-year sales to take advantage of potential capital losses has allowed investors to offset gains and reduce their overall taxable income. For example, selling a property at a loss just before the end of the tax year could lower the tax you owe on other gains.
This tactic, known as tax-loss harvesting, is particularly useful for real estate investors who may have diversified portfolios. However, it’s essential to remember the IRS’s wash-sale rule, which prevents you from claiming a loss if you repurchase the same asset within 30 days. Planning with the help of a financial advisor or CPA can make all the difference in how much you keep vs. how much you pay to the IRS.
Utilizing Tax-Advantaged Accounts
Maximize contributions to tax-advantaged accounts like IRAs and 401k accounts to defer or eliminate taxes on capital gains:
- Traditional IRA/401(k): Contributions are tax-deductible, and gains grow tax-deferred.
- Roth IRA/401(k): Contributions are not tax-deductible, but withdrawals are tax-free.
Harvesting Losses to Offset Gains
Tax-loss harvesting on your tax return to reduce gross income involves selling capital assets like real property and investments for a capital loss to offset gains from other investments:
- Offset Gains: Use losses to offset both short-term and long-term gains.
- Carryover Losses: If losses exceed gains, you can carry over the excess to future years.
Online Resources
For further reading and personalized advice, consider the following online resources like the Internal Revenue Service (IRS) website:
- IRS Publication 550: Investment Income and Expenses
- IRS Publication 523: Selling Your Home
- Tax Calculator: Texas 2024 Capital Gains Tax Calculator to know your tax liability.
- Consultation with a certified financial planner or financial advisor and tax professional to tailor strategies to your individual income and filing status.
By leveraging these resources and understanding the nuances of tax laws capital gains taxes in Texas, you can make informed decisions and optimize your financial outcomes.
Texas offers a highly favorable tax environment for any real estate investor due to its lack of state income tax. This advantage, combined with the federal tax benefits for long-term capital gains tax, can significantly increase after-tax returns for Texas residents. By understanding the rules and implementing strategic tax planning, you can effectively manage your capital gains and maximize your investment profits.
If you are considering selling your house or property in Texas, reach out to our team at Bright Bid Homes where we have over 40 years of investment experience to help you maximize and optimize your real estate and property sale price. Let us help you turn your property into a bright opportunity!
*** Disclaimer: As experienced real estate investors in Texas, we understand the importance of reducing the tax burden and any capital gains tax liability. This article offers insights based on our knowledge and experience, but it’s not a substitute for professional tax advice. Consult with a tax advisor for personalized guidance on your individual circumstances.