Texas is well-known for having no state income tax, and many property owners are attracted to the state because of its lack of taxation on income from sales of property. Nevertheless, Texas landowners still have to pay federal taxes on their gains under certain situations. Let's take a closer look at how capital gains from property sales work.

The general rule
Sales of property are treated in the same way as any other property held for investment. If you sell property, then any profit you make on top of what you paid for the property is treated as capital gain. Unless an exemption applies, that capital gain is taxable for federal purposes.

Exactly how that gain gets taxed depends on how long you've owned the property in question. If you've held the property for a year or less, then short-term capital gain treatment will apply. If you've held it for longer than a year, then any profit will be a long-term capital gain.

The personal residence exemption
One of the most common exemptions from capital gains tax involves personal residences. If you meet the requirements, you're allowed to make up to $250,000 for single taxpayers or $500,000 for joint filers on the sale of your home and not have to pay any capital gains tax on the sale.

To qualify, you generally must have owned the home and used it as your primary residence for at least two years out of the past five. In addition, you can't use the exemption multiple times in close succession, although you can sometimes get a partial exemption depending on the timing of the two transactions.

Like-kind exchanges
The other common way to avoid capital gains on the sale of a property is to make a like-kind exchange, also known as a section 1031 transaction. In a like-kind exchange, you essentially swap one property for another, sometimes with cash involved to account for any difference in value between the two properties. As long as you structure the transaction correctly, you can defer tax into the future.

Note that this method doesn't make gains tax-free. It only delays the day of reckoning, as your basis in the new property will be based on the original tax basis of the property you exchanged for it.

Texans are fortunate not to have to pay income tax at the state level. Even though they do have potential liability on a federal tax return, there are some good ways to take advantage of tax breaks to reduce or eliminate the consequences of a sale.

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