Capital Gains

What it is

Capital gains is what the IRS calls the profit when you sell something that went up in value. In real estate it breaks into two buckets.

Short-term is anything you held less than a year. The IRS taxes that at ordinary income rates — the same as if you had a job. If you flip a house, that’s what’s happening to you. You make $60,000 on a flip, you might be paying half of that or better to the IRS for your winnings. That’s not cool.

Long-term is for property you held more than a year. The rate is lower — much, much lower than ordinary income. So if you buy a rental, hold it for a couple years, and then sell, you get taxed at the long-term rate instead of getting crushed at ordinary income.

Then there’s the third category, which is the best one. Section 121, selling your primary residence. That’s not a lower rate. That’s zero.

Why it matters

My take on short-term capital gains is pretty direct: flippers get screwed. You’re paying active income rates on a deal you worked your tail off on. That’s why the whole holdco/opco structure exists — to move money into operating companies where you can set up a solo 401k, take expenses, and reduce what hits as ordinary income. You’re still paying taxes, you’re just not overpaying them.

Here’s the thing with a cash-out refinance, which is why it shows up as a wealth strategy. When you refinance a property and pull out $200,000, the IRS doesn’t touch it. That’s debt, not income. Elon Musk took out $12 billion in personal loans against his stock instead of selling it — he did it because when you sell the stock, you have to pay capital gains taxes on it, which is going to be pretty high for somebody that makes a lot of money. Real estate investors play the same game. Refinance, don’t sell.

The 1031 exchange is the other deferral tool. You sell a property, normally you’d pay capital gains on whatever profits you had, but in a 1031 exchange, you roll those proceeds into another property of equal or greater value and skip paying taxes on those capital gains. It’s kicking the can down the road, but sometimes kicking the can is the right call.

How it shows up

The short-term versus long-term line matters on every exit decision. If you’re thinking about selling a rental you’ve held for 10 months, you might want to wait another 60 days. That one timing choice is the difference between ordinary income rates and long-term capital gains rates.

For most active flippers, the real game is reducing what hits as taxable income in the first place — business expenses, depreciation, the opco structure — rather than hoping the capital gains rate is friendly. Defense over offense.

The Section 121 exclusion is in a separate category. That’s not a rate question, that’s a complete exemption. $250,000 of profit tax-free if you’re single, $500,000 if you’re married — no strings attached, as long as you’ve lived there two of the last five years. That’s why I spent the better part of a decade buying a house to live in, fixing it up, and selling every two years.

Related

primary residence, section 121 exclusion, 1031 exchange, depreciation, holdco opco, solo 401k, refinance, wealth engines