Capital Gains Tax 101: What Home Sellers Need to Know

When you sell your home, you may be wondering if you have to pay capital gains tax. This is a common question, and the answer depends on a number of factors. In this post, we'll explain what capital gains tax is, who has to pay it, and how much you may owe. We'll also provide some tips for minimizing capital gains taxes on a home sale and making the most out of any type of real estate investment. If you're looking for a smooth home sale, keep reading to become an expert on capital gains taxes.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.

What is Capital Gains Tax?

Capital gains tax is a tax on the profits from the sale of assets. The IRS defines an asset as anything that has value and can be sold, which includes stocks, bonds, and, of course, real estate.

How Much Is Capital Gains Tax on Real Estate?

The tax rate on capital gains from the sale of real estate is based on income level and ranges from 0% to 20%. The capital gains tax rate may be lower if the home functions as a primary residence.

The capital gains tax rate for the sale of a home depends on filing status. The following rates apply when selling a primary residence:

• 0% if annual income is $40,400 or less for single filers and $80,800 or less for married couples filing jointly;
• 15% if annual income is between $40,401 and $445,850 for single filers and between $80,801 and $501,600 for married couples filing jointly;
• 20% if annual income is over $445,851 for single filers or over $501,601 for married couples filing jointly.

Since the rates vary depending on your income level, it's important to consult a tax professional to determine how much you may owe.

Capital Gains Requirements and Restrictions when Selling Your Home

When a homeowner sells property, the IRS considers it a capital gain. This means you'll have to pay capital gains tax on any profits from the sale. There are a few exceptions, however, which we'll explain in more detail below.

If a home has been occupied for at least two years out of the last five, it qualifies as a primary residence. This means it can be sold at a lower tax rate. The two-year rule does not apply to people selling due to a job relocation, health reasons, or other unforeseen circumstances.

If the home has been occupied for less than two year, it may still qualify as a primary residence if it meets the "timely occupancy" rule. This rule requires the home to have been occupied for at least 183 days during the two years prior to the sale.

Capital gains tax rate will be based on standard tax brackets when selling a home that's not a primary residence and doesn't meet the timely occupancy criteria.

When Is a Home Sale Fully Taxable?

There are a few instances when a home sale is fully taxable. These include when the home is not the seller's principal residence, when the seller is subject to expatriate taxes, when the seller sold another home within two years from the date of the sale and used the capital gains exclusion for that sale, or when the property was not owned and used as the seller's principal residence for at least two of the last five years. Additionally, a home sale is fully taxable when the property was bought through a 1031 exchange.

Any home sale that falls into these categories will be charged a full capital gains tax. However, there are ways to reduce your tax liability. By consulting with a qualified real estate professional, sellers can learn how to use the capital gains exclusion and minimize taxes.

How to Avoid Capital Gains Tax on Home Sales

Fortunately, avoiding capital gains tax on a home sale is possible when certain requirements are met. As mentioned previously, the IRS allows sellers to exclude up to $250,000 ($500,000 for married couples filing jointly) of gain from taxes when selling a primary residence.

Sellers who don't meet the two-year requirement, can still lower your gains tax rates through allowable deductions from the cost basis of the home.

Cost basis is the original price of a property plus fees and expenses associated with the purchase, such as survey and title fees, real estate agent commissions, legal fees, and any improvements or high-ROI home improvements. 

Sellers can also take deductions for any losses on the sale of other investments to further reduce the total taxable gain.

By taking advantage of these exemptions and deductions, anyone can minimize or avoid capital gains tax on the sale of their home.

Let Our Team Help You With Your Home Sale Today

Whether you’ve owned your home for decades or just a few years, selling can be an exciting and nerve-wracking experience. It also comes with potential tax implications that may not have been on the forefront of your mind as you were considering the benefits of owning your own property.

To help make sure the home-sale process goes smoothly from start to finish, let our team assist you in preparing your home and getting it on the market. Contact us today for help from a local real estate expert on getting the best value for your home!

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.