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Short vs Long Term Capital Gains: What's the Difference?

Jerry Norton

Aug 8, 2024

brown and white concrete house under blue sky during daytime

If you’re considering selling a property as a part of your real estate business, you may be thinking of the profit that you can get from it. 

There is something that can actually reduce your profit: capital gains. 

Have you heard of them?

It’s critical to consider the capital gains will affect your profit when selling property — and, most importantly, how to reduce it. 

If you’re ready to learn everything you need to know about capital gains, let’s get started! 

What are Capital Gains?

Capital gains is the profit from selling a “capital” asset — such as real estate — at a higher price compared to its original purchase price. 

Thus, these “gains”, which are subject to taxes, are essentially the difference between the selling price and the cost basis of the property.

Types of Capital Gains

Capital gains can be categorized into two types: short-term and long-term. 

In order to determine which one you fall into, you must calculate how long you've held the property, counting from the day after the day you acquired it up until the day you sold it.

Short Term Capital Gains

Short-term capital gains are generated from property held for one year or less, which comes into play for house flippers.

Short term capital gains are taxed as regular income by the IRS. This means they are subject to whichever tax bracket you currently fall under.

Long Term Capital Gains

On the other hand, long-term capital gains are from property held for more than one year. 

Because long-term capital gains are usually taxed at a more favorable rate than short term capital gains, you can reduce your capital gains bill by keeping a property for a year or more.

This being said, there are exceptions to these two types of capital gains tax, including:

  • if the property is acquired as a “gift”
  • if the property acquired from a descendant or through the probate process.

If either of these apply to your situation, use Publication 544 for more info. 

How To Calculate & File Capital Gains

Now that we've broken down the types of capital gains, let's take a look at how to calculate them.

Step 1: Calculations

To calculate capital gains, you’ll first need to determine the amount that you’ve gained by subtracting your original purchase price (what's called the “basis”) from the amount you’ve sold the property (what's called “the realized amount”). 

Step 2: IRS Form

After you have done this calculation, you’ll then report this amount on IRS form D.

Next, we’ll look at the type of capital gains that factor into your tax bill. 

Legal Ways to Avoid Capital Gains Tax

While it is not possible to avoid capital gains tax, there are ways to reduce it, including:

Deferring capital gains through 1031 exchange. 

A 1031 exchange is a powerful tool that allows you to reinvest the proceeds from the sale of one property into another similar property. By doing so, you are deferring capital gains tax.

Adjust Your "Basis".

You can adjust the amount you originally paid for the property — what's known as the basis — by including fees associated with the sale, such as closing costs, along with the cost of home improvements.

Invest through self-directed IRAs. 

By utilizing self-directed IRAs, you can defer your capital gains tax.

Utilizing capital gains tax exemptions available for primary residences.

As a homeowner, you may be eligible for certain IRS exemptions that can reduce your capital gains tax in the event that you sell your primary residence.

The Bottom Line: Capital Gains

There you have it: capital gains. 

If you didn't already know, it can eat away at your profit margin when selling a house — if you don't find specific ways to reduce it.

Use this article to reduce your capital gains tax bill so that you can reinvest more money into your real estate business.