Capital gains tax on land can be a headache, but as you’ve seen, the right plan can save you a lot of money.
Before diving into the strategies, ensure you understand the basics of capital gains tax on real estate.
For a solid foundation on what capital gains tax is check out our detailed guide: Capital Gains Tax on Real Estate.
Deferral Strategies
Sometimes, simply timing your sale can have a significant impact on your tax bill. Understanding the difference between short-term and long-term capital gains is your first step.
First, make sure the sale is at least one year after your purchase to avoid short-term capital gains. Short-term gains are taxed at your ordinary income tax rate, which is typically much higher than long-term capital gains tax rates.
If you don’t need to sell right away, think about deferring the closing date until the next year. This can be especially beneficial if you anticipate your overall income will be lower in the upcoming year, potentially placing you in a lower tax bracket for your capital gain.
Lastly, it’s worth investigating if your state has a specific holding period or special rules to avoid state-level capital gains. For example, states like Oklahoma and Vermont have unique provisions worth researching. Other states don’t have income tax at all and thus don’t tax capital gains.
Wondering how your state taxes capital gains?
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Installment Sale
An installment sale is one of the most powerful and often overlooked strategies for managing capital gains tax on land sales.
Installment sales, also known as seller financing, are common in land sales. Sometimes you’ll see such properties advertised as ‘Owner Will Carry.’
How it Works
Instead of receiving a lump sum payment, you structure the sale to receive payments over multiple tax years, effectively spreading out your capital gains tax liability and potentially staying in a lower tax bracket.
Key Benefits
- Lower Tax Burden: Spreads your tax liability across several years.
- Steady Income: Provides a consistent, predictable income stream.
- Sell Faster & For More: Makes your land accessible to more buyers, which can lead to a quicker sale at a better price.
What to Consider
- Buyer’s Creditworthiness: Since you’re acting as the bank, it’s wise to get a significant down payment. We typically ask for 20% or more.
- Administrative Work: There’s an administrative burden to collecting payments and handling taxes, but software like Terra Notes can make this easier.
We have direct experience with installment sales — it’s our preferred sale method for our land selling business for all the reasons mentioned.
Installment sales are ideal for landowners who don’t need all their cash upfront and want a stable income while minimizing their immediate tax burden.
Case Study: How an Installment Sale Saved Thousands
Let’s look at a simple example to see how this works.
Meet John and Mary, a retired couple. They have a regular income of $80,000 per year. They sell a piece of land they’ve owned for years for a $100,000 profit.
To keep things simple, let’s say the long-term capital gains tax rules for a married couple are:
- 0% Tax: On total income up to $94,000.
- 15% Tax: On total income above $94,000.
(Note: These are based on real tax brackets but simplified for this example.)
Option 1: They take all the money at once.
This one-time profit gets added to their regular income for the year.
- $80,000 (Regular Income) + $100,000 (Land Profit) = $180,000 Total Income
Because their income is now far above the $94,000 limit, a large chunk of their profit gets taxed at 15%.
- The first $14,000 of their profit fills up their 0% tax bucket. Tax = $0.
- The remaining $86,000 of their profit is taxed at 15%.
- Tax Bill: $86,000 x 0.15 = $12,900
They would have to write a $12,900 check to the IRS.
Option 2: They use an installment sale over 10 years.
They decide to receive their $100,000 profit in smaller chunks of $10,000 per year for 10 years.
- $80,000 (Regular Income) + $10,000 (Land Profit) = $90,000 Total Income each year.
Look at that! Their total income of $90,000 is less than the $94,000 limit for the 0% tax rate.
- Tax Bill: $0.
They do this for 10 years, and their tax bill on the profit remains zero each year.
The Result
By choosing an installment sale, John and Mary saved the entire $12,900 in taxes. This simple strategy gave them a steady, tax-free income stream and let them keep all the money they earned from their land.
1031 Exchange (Like-Kind Exchange)
A 1031 exchange, or a like-kind exchange, is a powerful tool for investors. It lets you defer capital gains tax by rolling the entire profit from a sale directly into a new “like-kind” property. You’re essentially swapping one investment for another without cashing out, which means no immediate tax bill.
In a 1031 exchange, like-kind means any real estate held for investment or business, regardless of type, location, or value—as long as the replacement is also for investment or business use.
Examples of Like-Kind Exchanges
The term “like-kind” is surprisingly broad. All of the following are considered like-kind under 1031 rules:
- 🌳 Vacant land ⟶ 🏢 Apartment building
- 🛍️ Retail building ⟶ 🏭 Industrial warehouse
- 🏡 Residential rental property ⟶ 💼 Office condo
- 🌾 Farmland ⟶ 🏖️ Vacation rental property
The Rules
The IRS has strict rules for a 1031 exchange. The most important are the timelines:
- 45-Day Rule: You have just 45 days from the sale of your property to formally identify potential replacement properties.
- 180-Day Rule: You must close on the new property within 180 days of the original sale.
A Qualified Intermediary (QI) is required to handle the funds. They hold your profit from the first sale and use it to purchase the second property, ensuring you never technically “receive” the cash, which is key to deferring the tax.
The Benefits & Risks
The main benefit is clear: you get to reinvest 100% of your profit, which boosts your buying power. However, you must follow the timelines exactly. Missing a deadline can disqualify the exchange, leaving you with an unexpected tax bill. Both properties must also be for investment or business use, not personal use.
Basis Carryover
Note than a 1031 exchange only defers capital gains tax. The original cost basis transfers to the new property.
When you eventually sell (without another exchange), you’ll owe tax on both the deferred gain and any new appreciation.
You’re not avoiding tax — just postponing it while keeping more capital invested.
Case Study: How a 1031 Exchange Boosts Buying Power
A 1031 exchange is perfect for investors who want to grow their portfolio. Let’s see how.
Meet Alex, an investor who sells a piece of land and makes a $200,000 profit. His capital gains tax rate is 15%.
Option 1: Pay the Tax
If Alex just takes the profit, he has to pay taxes on it right away.
- Profit: $200,000
- Tax Bill: $200,000 x 0.15 = $30,000
After paying the IRS, Alex has $170,000 of his profit left to buy a new property.
Option 2: Use a 1031 Exchange
Instead, Alex uses a 1031 exchange. He works with a professional (a Qualified Intermediary) who handles the money so he can buy a new “like-kind” property.
- Profit: $200,000
- Tax Bill: $0 (Deferred)
Because he deferred the tax, Alex can roll the full $200,000 of profit into his next purchase. He now has an extra $30,000 in buying power.
The Result
By deferring $30,000 in taxes, Alex was able to “trade up” to a larger, more valuable property.
Step-Up in Basis Upon Inheritance
One of the most advantageous tax rules for inherited property is the “step-up in basis.” When property is inherited, its cost basis is “stepped up” to its fair market value at the time of the previous owner’s death. This is incredibly important for inherited land sales.
What does this mean for you? If you inherit land that has appreciated significantly, and you then decide to sell it relatively soon after the inheritance, you will likely owe little to no capital gains tax on the appreciation that occurred during the deceased’s ownership. Your basis is essentially reset to the property’s value on the day the original owner passed away. This can be a huge tax saving for heirs.
Tax Loss Harvesting
Tax loss harvesting is a strategy that involves using capital losses from other investments to offset your capital gains from the land sale. If you have sold other assets, like stocks or mutual funds, at a loss, you can use these losses to reduce your taxable gains.
Here’s how it works: You can use your capital losses to offset capital gains dollar-for-dollar. If your capital losses exceed your capital gains, you can then use up to $3,000 of the remaining loss to offset your ordinary income each year. Any unused losses can be carried forward to future tax years. This strategy can be a very effective way to reduce your overall tax burden, especially if you have a significant capital gain from selling your land.
Charitable Remainder Trust (CRT)
A Charitable Remainder Trust (CRT) is an advanced estate planning tool that can provide significant tax benefits when selling highly appreciated land. With a CRT, you donate your land into an irrevocable trust, which then sells the asset tax-free.
The trust pays you or your designated beneficiaries an income stream for a specified period (either a term of years or for life), and when that period ends, the “remainder” of the trust assets goes to a charity of your choice. The benefits are compelling: you avoid immediate capital gains tax on the sale of the land, you receive a charitable income tax deduction in the year you establish the trust, and you generate a steady income stream. However, it’s an irrevocable decision, meaning you can’t change your mind once the land is in the trust, and it involves specific IRS rules.
Gifting Property
Gifting property involves transferring land ownership to another individual, such as a family member, during your lifetime. From the donor’s perspective, gifting the property means you avoid paying capital gains tax on the appreciation that occurred while you owned it.
However, it’s important to understand the recipient’s perspective. The recipient takes on the donor’s original cost basis (known as a “carryover basis”). This means that if the recipient later sells the land, they will be responsible for paying capital gains tax on the full appreciation from the time you originally acquired it. Be aware of gift tax implications; while there’s an annual exclusion limit, gifts exceeding a certain amount will count towards your lifetime gift tax exclusion.
Primary Residence Exclusion (If the land includes a primary residence)
If the land you’re selling includes your primary residence, you might qualify for the Section 121 exclusion. This powerful provision of the tax code allows homeowners to exclude up to $250,000 (for single filers) or $500,000 (for those married filing jointly) of capital gains from the sale of their main home.
To qualify, you must have owned and used the property as your primary residence for at least two of the last five years leading up to the sale. This exclusion is directly applicable to land sales where the land is part of your primary residence property, providing a significant tax break on the portion of your gain attributable to the home and its surrounding land.
Investor vs. Dealer: A Key Tax Distinction
Your tax rate for a land sale depends on whether the IRS classifies you as an “investor” or a “dealer.” Investors pay lower, long-term capital gains tax. Dealers are considered to be in the business of selling real estate, and their profits are taxed as higher-rate ordinary income.
You may be deemed a dealer if you frequently sell properties, make significant improvements like subdividing, or actively market the land.
To avoid having all profit taxed at the higher dealer rate, developers can sell their appreciated land to a separate S corporation they own. This locks in the lower capital gains rate on the land’s appreciation before development begins. Only the subsequent profit from the S corporation’s development and sales is then treated as ordinary income.
Frequently Asked Questions (FAQs)
What is a simple trick for avoiding capital gains tax?
There are no truly simple tricks for avoiding capital gains tax. There are many ways to defer or reduce capital gains tax, but they often involve trade-offs—such as limited flexibility, stricter IRS rules, or delayed access to your money.
Is land taxable as a capital gain?
Yes, generally, profit from the sale of land is considered a capital gain and is subject to capital gains tax, unless specific exclusions or deferral strategies apply.
Do you have to pay taxes on land you sell that you inherited?
You generally do not pay capital gains tax on the appreciation that occurred before you inherited the land due to the “step-up in basis.” However, if you sell the land for more than its fair market value at the time of inheritance, you will pay capital gains tax on that subsequent appreciation.
How do you offset capital gains on a property sale?
You can offset capital gains by using capital losses from other investments (tax loss harvesting), deferring the gain through a 1031 exchange, spreading the gain over time with an installment sale, or utilizing strategies like a Charitable Remainder Trust.
Conclusion
Capital gains tax on land can be a headache, but as you’ve seen, the right plan can save you a lot of money.
Whether it’s through the structured payments of an installment sale, the deferral power of a 1031 exchange, or leveraging inheritance laws, there are actionable ways to keep more of your profit.
Please consult your financial advisor, accountant, real estate attorney, or tax specialist. This article is for informational purposes and is not tax or legal advice.
