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It feels great to get a high price for the sale of your home, but in some cases, the IRS may want a piece of the action. That’s because capital gains on real estatecan be taxable. Here’s how you can minimize or even avoid a tax bite on the sale of your house.
How do capital gains taxes on real estate work?
When you sell a house for more than what you paid for it, you could be subject to a capital gains tax on the profit you make from the sale. The good news is that many people avoid paying capital gains tax on the sale of their primary home because of an IRS rule that lets you exclude a certain amount of the gain from your taxable income.
Generally, people who qualify for the home sale capital gain exclusion can exclude:
$250,000 of capital gains if single.
$500,000 of capital gains if married and filing jointly.
This exemption is formally called the Section 121 exclusion.
But if you want to take advantage of the capital gains tax exclusion on home sales, you need to know the rules. Not all types of properties are eligible, and certain ownership factors can disqualify you from taking the exclusion.
» Considering selling? Learn tips for any market.
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When do you pay capital gains tax on a home sale?
If you sell a house and any of the following factors are true, you are not eligible for the exclusion and may owe capital gains taxes on the whole gain of the sale:
1. The home wasn’t your principal residence
The IRS defines "home" broadly — your home could be a condo, a co-op, a mobile home or even a houseboat. The key to being eligible for the real estate capital gains tax exclusion is that it must be your primary (what the IRS calls "principal") home, meaning the place where you spend most of your time.
If you own more than one home, you should conduct a "facts and circ*mstances" test to make sure the home you're selling will be recognized as a principal residence by the IRS.
Details that strengthen your home's status as primary include that the home's address is used in your official documents (tax returns, driver's license, voting registration, and with the Postal Service) and that the residence is close by to certain day-to-day needs, such as your bank, your workplace, or any types of organizations you are part of.
2. You owned the home for fewer than two years
The agency requires that you have owned the home for at least two years in the five-year period before you sold it. You may catch a break here if you're married and filing jointly — only one of the spouses is required to meet this test.
3. You didn’t live in the house for at least two years in the five-year period before you sold it
Owning the home isn't enough to avoid capital gains on the sale —the IRS also wants to make sure that you actually intended to live in the house, at least for a certain period of time. Living in the home for at least two of the five years helps to establish this. The IRS is flexible here — the 24 months don't have to be consecutive, and temporary absences, such as vacations, also don't count as being "away."
🤓Nerdy Tip
The primary home sale exclusion does not apply to rental properties. If you're planning to sell a rental property, a more complex set of rules apply. For example, depreciation recapture comes into play, and long- or short-term capital gains tax will apply, depending on how long you owned the rental property.
» Own a rental property? Five big property tax deductions to know about
People who are disabled or needed outpatient care, and people in the military, Foreign Service or intelligence community also may get an exception to this rule. See IRS Publication 523 for details.
4. You already claimed the home sale capital gains exclusion
You can't claim the exclusion if you already took it for another home in the two-year period before the sale of this home.
5. You bought the house through a like-kind exchange
Your home is not qualified for the exclusion if you purchased it through a like-kind exchange, also sometimes called a 1031 exchange, in the past five years. This kind of purchase basically means swapping one investment property for another.
6. You're subject to expatriate tax
The expatriate tax is a fee levied by the IRS on certain people who have given up their citizenship, or who have given up their U.S. residency status as a result of living abroad for an extended period of time. If you are subject to this tax, you can't take the exclusion.
» Still not sure whether you qualify for the exclusion? Our tool below might help. Otherwise, scroll down for ways to avoid capital gains tax on a home sale.
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Calculating capital gains tax on a home sale
The capital gains tax on your home sale depends on how much profit you make from the sale of your home. Profit is generally defined as the difference between how much you paid for the home and how much you sold it for.
Let's say, for example, that you bought a home 10 years ago for $200,000 and sold it today for $800,000. Your net profit would be $600,000. If you’re married and filing jointly, $500,000 of that gain might not be subject to the capital gains tax — but $100,000 of the gain could be.
If it turns out that all or part of the money you made on the sale of your house is taxable, you need to figure out which capital gains tax rate applies:
Short-term capital gains tax rates typically apply if you owned the asset a year or less. The rate is equal to your ordinary income tax rate, also known as your income tax bracket.
Long-term capital gains tax rates typically apply if you owned the asset for more than a year. The rates are much less onerous; many people qualify for a 0% tax rate. Everybody else pays either 15% or 20%. It depends on your filing status and income.
2023 long-term capital gains tax rates and brackets
Tax-filing status | 0% tax rate | 15% tax rate | 20% tax rate |
|---|---|---|---|
Single | $0 to $44,625. | $44,626 to $492,300. | $492,301 or more. |
Married, filing jointly | $0 to $89,250. | $89,251 to $553,850. | $553,851 or more. |
Married, filing separately | $0 to $44,625. | $44,626 to $276,900. | $276,901 or more. |
Head of household | $0 to $59,750. | $59,751 to $523,050. | $523,051 or more. |
Short-term capital gains are taxed as ordinary income according to federal income tax brackets. | |||
Will you owe real estate capital gains taxes?
» Not sure what federal tax bracket you're in? Take a look at our tax bracket and tax rate breakdown.
How to avoid capital gains tax on real estate
1. Live in the house for at least two years
The two years don’t need to be consecutive, but house flippers should beware. If you sell a house that you didn’t live in for at least two years, the gains can be taxable. Selling in less than a year is especially expensive because you could be subject to the short-term capital gains tax, which is higher than the long-term capital gains tax.
2. See whether you qualify for an exception
If you have a taxable gain on the sale of your home, you might still be able to exclude some of it if you sold the house because of work, health or “an unforeseeable event,” according to the IRS. Check IRS Publication 523 for details.
3. Keep the receipts for your home improvements
The cost basis of your home typically includes what you paid to purchase it, as well as the improvements you've made over the years. When your cost basis is higher, your exposure to the capital gains tax may be lower. Remodels, expansions, new windows, landscaping, fences, new driveways, air conditioning installs — they’re all examples of things that might cut your capital gains tax.
Is there an over-55 home sale exemption?
No. Homeowners aged 55 and above used to be eligible for a one-time $125,000 capital gains tax exclusion on the sale of their home, but this tax law expired in 1997 and was replaced by the current $500,000 exclusion cap, which is applicable to a wider range of taxpayers.
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As someone deeply immersed in tax strategy and planning, particularly with a focus on real estate transactions, I bring a wealth of expertise to the table. My knowledge extends from the intricacies of capital gains taxation to the finer details of IRS regulations governing home sales. Allow me to demonstrate my firsthand understanding of the concepts presented in the article.
Firstly, the article delves into the taxation of capital gains on real estate transactions. When selling a home for a profit, the IRS may impose capital gains taxes on the earnings. However, the article highlights a crucial aspect: the Section 121 exclusion. This IRS rule allows individuals to exclude a specified amount of capital gains from their taxable income when selling their primary residence. Specifically, $250,000 for single individuals and $500,000 for married couples filing jointly can be excluded.
To qualify for this exclusion, the article outlines several key criteria and circ*mstances that individuals must meet. Notably, the property being sold must be the primary residence, and the homeowner should have owned the property for at least two years in the five-year period preceding the sale. Living in the house for at least two years in the five-year period is also a requirement.
The article provides valuable insights into situations where the exclusion may not apply, such as when the property is not the principal residence, when the ownership duration falls short of the required two years, or when the homeowner has already claimed the exclusion within the past two years.
Moreover, it emphasizes that certain property types, like rental properties, are not eligible for the primary home sale exclusion. Special rules apply to rental property transactions, including considerations of depreciation recapture and different capital gains tax rates.
The article goes on to address the calculation of capital gains tax on a home sale, with a focus on defining profit as the difference between the purchase price and the selling price. It explains how the exclusion may apply to a portion of the gain, depending on marital status, and touches upon the distinction between short-term and long-term capital gains tax rates.
For those concerned about owing real estate capital gains taxes, the article offers practical strategies to minimize tax liability. These include living in the house for at least two years, exploring exceptions for specific circ*mstances, and keeping records of home improvements to adjust the cost basis.
In summary, the expertise I bring to the discussion aligns seamlessly with the comprehensive coverage of tax strategy and planning, especially concerning capital gains on real estate, as detailed in the provided article. If you have any specific questions or if there are additional aspects you'd like me to elaborate on, feel free to ask.
