Capital gains taxes are levied on the gain that an investor realizes when he or she sells capital assets, including real estate, for a price that is higher than the purchase price.

For the purpose of this explanation, we will focus strictly on capital gains taxes as they relate to real estate. Capital gains taxes are only triggered when the property is sold, not while it is held by an investor. An investor can own property that appreciates every year, but the investor does not incur a capital gains tax on the appreciation until it is sold.

For many years, investors whose overall income put them in the top four income-tax brackets faced a long-term capital gains rate of 20 percent, while lower-income investors paid capital gains taxes of 10 percent. Tax-law changes in May 2003, however, lowered the rates by 5 percent each. Investors in the higher-income ranges, now find their capital gains taxed at 15 percent — a substantial penalty based on the sale of property.

These rates were scheduled to end on Dec. 31, 2008 but have been extended through 2010.

Real estate investors seeking to defer capital gains taxes on the sale of property may utilize IRS Section 1031, which allows investors to "exchange" properties. In an exchange, where an investor wishes to completely defer any capital gains tax, the investor must invest in a property (or properties) that are equal or greater in value than the property that was sold, re-invest all of the equity in the newly purchased ("replacement property"), and maintain an equal or greater level of debt in the replacement property. As a result of the exchange, capital gains tax on the real estate investment sale is deferred.

For more information on how much tax on capital gains, please click here.