How to Avoid Capital Gain Taxes on Selling Land in Texas

They say that taxes are one of two certainties in life. It's also certain that no one wants to pay more than their share of taxes. But interpreting tax laws can be confusing, especially when selling property. If you're considering selling a property in Texas, you want to know how much you'll keep after paying the taxes. You probably also want to know if there are ways to avoid or minimize the taxes you'll owe.

In this article, learn about taxes on land sales in Texas and how you can minimize your tax liability.

Key Takeaways

  • Texas has no state income tax, but you may owe federal capital gains taxes on the sale of land
  • Short-term capital gains are taxed as ordinary income, while long-term gains are taxed at 0-20%
  • Exemptions include income thresholds and primary residence for two of the last five years
  • Strategies to avoid capital gains tax include 1031 exchanges and installment sales

What taxes will I be charged when selling land in Texas?

Texas has no state income tax, so you will not be charged state taxes. But you may still owe federal capital gains taxes. How much capital gains tax you'll owe depends on the profits made on the sale, how long you've owned the property, and your tax bracket.

What are capital gains taxes?

When you sell property such as land, the IRS may tax you on the "capital gain" of the sale. The capital gain is the amount you make from the sale, above and beyond the amount you originally paid for the asset.

For example, if you buy a piece of land for $50,000 and sell it for $60,000, you would have to pay taxes on the $10,000 capital gain. 

Short-term vs. long-term capital gains tax rate

Short-term and long-term capital gains are taxed at different rates. Short-term gains are taxed as ordinary income according to your tax bracket. For capital gains, short-term means the property was held for less than a year.

Long-term capital gains result from selling a property after one year or more. Long-term capital gains are taxed at rates between 0% and 20% in most instances. For many, long-term capital gains tax rates are lower than short-term tax rates. That means holding property for at least a year may result in paying lower taxes.

Texas capital gains tax exemption

There are two types of exemption from paying capital gains taxes:

  1. Income. There is a threshold of ordinary income before capital gains are triggered. If your taxable income is below this threshold, you won't owe capital gain taxes. See the income levels for the 0% long-term capital gains rate in the table below.
  2. Primary residence. If the property was your primary residence for two of the last five years, you might qualify for an exemption. This may not be likely when selling land, but it may apply if you're selling your home that includes large acreage. If you qualify, you will not pay taxes on the first $250,000 of capital gain if single or $500,000 if married. There are several other requirements, so consult IRS guidelines. 

How do I sell land without paying capital gains tax?

If you don't qualify for an exemption, you still have options to avoid paying capital gains tax.

  1. 1031 exchange. A 1031 exchange is possible if you want to sell a particular property but don't need the money immediately. In a 1031 exchange, you sell a property and then have a period of time to reinvest your sales proceeds in a new property. Note that a 1031 exchange is only a way of deferring capital gains. You would still owe taxes if you sold the new property with a capital gain.
  2. Installment sale. An installment sale is when a property is sold, but the total amount is not paid at the time of purchase. At least one payment is made after the tax year of the sale. The purpose of an installment sale is to defer capital gains over several years and possibly reduce the overall tax liability.

Capital gains tax Texas calculator

People tend to hold land for many years. So, for most property owners, a property sale will result in a long-term capital gain. Follow these steps to determine long-term capital gains tax.

  1. Determine your cost basis. Your basis depends on how you came to own the property. If you bought the property, the cost basis is the purchase price plus any commissions, fees, or improvements. If you inherited the land, the cost basis is either 1) the fair market value on the day of the original owner's death or 2) the fair market value on the day the property was transferred to you, plus commissions, fees, or improvements.
  2. Subtract your cost basis from the amount you sold the property for. If you have a positive number after subtracting your basis, you have a capital gain.
  3. Reduce your capital gains with long-term losses, if applicable. You can reduce your capital gain if you have long-term capital losses in the same year or carried over from a previous year.
  4. Check the long-term capital gains tax table below. Find the bracket that represents your filing status and taxable income. The corresponding tax rate — 0%, 15%, or 20% — would be the tax on your capital gain.

Long-term capital gains tax rates in 2023

Tax Rate Single Married, Filing Jointly Married, Filing Separately Head of Household
0% $0 to $44,625 $0 to $89,250 $0 to $44,625 $0 to $59,750
15% $44,626 to $492,300 $89,251 to $553,850 $44,626 to $276,900 $59,751 to $523,050
20% $492,300 or more $553,850 or more $276,900 or more $523,050 or more

Example of calculating capital gains tax

Here's a real-world example of calculating capital gains taxes for a property sale. Let's say Joseph bought a property eight years ago for $25,000. Later, he spent $5,000 on improvements - bringing utilities to the property. His cost basis in the property is $30,000.

Joseph sells the property for $40,000, netting $36,000 after $4,000 of commissions and fees. His capital gain is $6,000 ($36,000 minus $30,000).

Joseph is single, and his ordinary taxable income is $80,000. The 15% capital gain tax rate will apply to his $6,000 gain. The resulting capital gain tax is $900.

Capital gains tax on inherited land

In Texas, there is no inheritance tax. You will not owe any taxes to in Texas for a property that you inherit

But you may owe federal taxes if you sell the property. When you inherit real estate, the property's cost basis adjusts to fair market value. That means that if you sold the property right away, you would owe little or no capital gains tax.

If you wait to sell and the value increases, you may owe capital gains tax. Short-term capital gains will apply if you sell the property with a gain less than a year after inheriting. Long-term gains will apply if you sell the property after a year or more. The taxable amount would be the difference between the sale price and the value at inheritance. The tax rate on capital gains is 0%, 15%, or 20%, depending on your tax bracket and filing status.

Conclusion - avoiding capital gains taxes in Texas

Avoiding capital gains tax on real estate sales takes some planning. There are exemptions available that can completely eliminate taxes when selling. Even if you don't qualify for an exemption, there are still ways to avoid paying capital gains or defer the tax. Being aware of these exemptions and strategies can help to minimize the amount of tax you'll have to pay.

Please consult your financial advisor, accountant, real estate attorney, or tax professional. This article is for informational purposes and is not tax or legal advice.