How Much Is the Capital Gains Tax on Real Estate? (2024)

Taxes

Investing and Taxes

Real Estate Investment Taxes

11 Min Read | Jan 5, 2024

How Much Is the Capital Gains Tax on Real Estate? (1)

By Ramsey

How Much Is the Capital Gains Tax on Real Estate? (2)

How Much Is the Capital Gains Tax on Real Estate? (3)

By Ramsey

So, you sold your home and just left the closing attorney’s office with a fat check. Not just a big check—but the biggest check you’ve ever held in your sweaty palm.

After the excitement fades and you recover from your celebratory steak dinner, you might be wondering:Do I have to pay taxes on a home sale?The answer ismaybe.

The IRS calls profits from the sale of a home or another investmentcapital gains. And capital gains are taxed at different rates depending on whether the investment you made was short-term (less than one year) or long-term (over one year). The rates also vary depending on your income.

But, hey, don’t lose hope just yet. The great news about selling a home is that the profit is often exempt fromcapital gains taxes. That’s right! Tax-free, baby. But just like anything tax-related, there are some hoops to jump through.

How Much Is Capital Gains Tax on the Sale of a Home?

Okay, so here’s the deal. If the home you sold was your primary residence for at least two of the last five years, you don’t have to pay capital gains taxes on your profit up to a certain amount. And the IRS is pretty generous (for once!) on how much profit they exclude from taxes.

If you’re single, any profit up to $250,000 is excluded from taxes. For married filing jointly, the amount doubles to $500,000.1

Now, profit doesn’t simply mean how much money you got when you sold your house. Profit is the sales price minus the original purchase price and the cost of improvements, fees and commissions. Now if the housing market in your area has gone bonkers, and you cleaned up on the sale of your house, you only pay taxes on the profit amount above the $250,000 or $500,000 threshold.

Let’s look at an example. Say you and your spouse bought a house 10 years ago for $300,000 in an up-and-coming part of town. You followed our recommendations and put 20% down ($60,000) and got a15-year fixed-rate mortgage. After 10 years of payments, you owed just $93,000 when you decided to sell. The home values in your area have shot up like crazy, so you were able to sell your home for $900,000! Boom! You couldn’t stop smiling for a week.

So, to figure out your profit, you take $900,000 and subtract the original $300,000 sales price, about $55,000 in commissions and fees, and let’s say $20,000 in home repairs (a roof and new furnace). That equals $525,000 profit. Since the tax-free threshold for married couples is $500,000, you’ll pay capital gains taxes on just $25,000.

What Is the Capital Gains Tax Rate on a Primary Residence?

So, $525,000 is a big pile of money, but since you only owed $93,000 on your home, you actually walked away with $752,000. Here’s the math: $900,000 (sales price) - $55,000 (commissions and fees) - $93,000 (mortgage payoff) = $752,000.

Now to your tax bill:

  • Short-term (less than one year) capital gains are taxed at your regular income tax rate.
  • Long-term (more than one year) capital gains are taxed based on your income. And for the 2023 tax year, if your taxable income is less than $44,625 for single filers or $89,250 for married filing jointly, your long-term capital gains tax rate is 0%!2

The long-term capital gains rate is 15% for single filers with taxable incomes between $44,625 and $492,300 and for couples filing jointly with incomes between$89,250 and $553,850.Above those amounts, the rate is 20%.3

Notice these rates are much lower than normalfederal income tax brackets.

Taxes don’t have to overwhelm you. See what’s best for your situation—and services you can trust.

The real median household income in the United States in 2022 was $74,580.4So that means a good number of people who have long-term capital gains, depending on whether they’re single or married, fall into the 15% bucket (or are right on the border).

Let’s go back to our example where your taxable profit was $25,000. Assuming your household income puts you in the 15% capital gains bracket, you’ll owe $3,750 in taxes. Yes, that’s a lot of money, but when you consider you got $752,000 from the sale of your home, it’s small potatoes.

How to Avoid or Reduce Capital Gains Tax on Home Sales

If you met the two-year residency requirement, meaning your home was your primary residence for at least two of the last five years (and you have the random carpet stains to prove it), you probably won’t get hit by capital gains taxes when you sell your home because the profit threshold ($250,000 to $500,000) is so high.

But if you earned a profit on a home you lived in for less than two years, the Tax Man is going to come calling. And he could hit you with a big bill! Whether you fix up andflip housesor just decided to move to a new neighborhood, if you don’t meet the residency requirement, you’ll be taxed on your profit at either your regular income tax rate (if you owned the house for less than a year) or the capital gains rate (if you owned the house over a year).

There are a few ways to avoid the capital gains tax, but the big one is to stay put! Don’t sell your house before you’ve owned it for two years.

Capital Gains Tax Residency Exclusions

The IRS has several exclusions to the residency requirement.

  • If you’re a member of the Armed Forces and get called up to active duty, you qualify for an exclusion.
  • Other “unforeseeable” circumstances also qualify for an exclusion, like if the home was destroyed, condemned or suffered a loss due to a natural or man-made disaster.5
  • You also qualify if a primary resident of your home died, got divorced or legally separated, gave birth to twins or other multiples, lost their job, or could no longer afford the home due to a change in employment.6

The IRS also has partial exclusions if you sold your home due to a job relocation, a health issue that required you to be closer to medical facilities for a family member, or to provide personal care for a family member with an illness.7A partial exclusion is calculated based on how long you lived in the home.

So, if you’re single and lived in your home for one year (half of the two-year residency requirement), you qualify for 50% of the $250,000 exclusion. That’s $125,000. As you get closer to the two-year requirement, the amount you can exclude increases.

If you don’t qualify for an exclusion, your best bet for lowering your tax bill (at least a little) is to create a detailed list of all the improvements you made to your home so you can subtract them from your profit. Bought a new hot water heater? Replaced the windows? You can subtract those costs from your profit.

The real estate market is crazy right now, and house prices in many cities increased by double digit percentages last year. So that means you could get hit by a big tax bill if you decide to sell your home before you meet the two-year requirement.

But in a normal market, if you sell a house after owning it for less than two years, most (if any) of your profit will be eaten up by real estate agent fees (typically 6% of the sales price) and closing costs. The longer you stay put in your home, the more equity you earn (equity is how much your home is worth, minus how much debt you owe on it).

How Much Is the Capital Gains Tax on a Rental Property?

If you own a rental property, the rent you collect is considered regular income, and you’ll pay taxes on it like a normal paycheck. But if you decide to sell the property, you’ll owe capital gains taxes on your profit. And since a rental is not your primary residence, you won’t be able to exclude a portion of your profit.

So if you owned the property for less than a year, you’ll pay short-term capital gains taxes at your normal income tax rate. If you owned the property over a year, you’ll pay long-term capital gains taxes at a rate of 0%, 15% or 20% depending on your income. (We talked about those income ranges earlier.)

How to Avoid Capital Gains Tax on a Rental Property

Just like selling a primary residence, you can subtract the cost of improvements, real estate commissions, and closing costs from the gain you earned on your rental property. That’ll lower your tax burden some, but the really cool way to avoid capital gains taxes is doing a1031 exchange. Ugh, the IRS and their numbered forms. But hang with us—this’ll be worth it.

A 1031 like-kind exchange allows you to defer paying capital gains taxes if you reinvest the proceeds from the sale of a property into another similar property. That’s right: If you sell a rental home and buy another with the money you made on that sale, you won’t have to pay capital gains taxes on the sale. The IRS allows you to do as many 1031 exchanges as you want, but as soon as you stop investing your proceeds into similar properties, you’ll have to pay capital gains taxes.

The IRS is somewhat flexible on the term similar. For instance, you could sell a rental home and buy a commercial property or an apartment complex and defer capital gains taxes. But you couldn’t sell a home and invest the money in mutual funds or some other investment likecryptocurrency(crypto is never a good idea anyway). Well, technically, you could. You’ll just have to pay taxes on it.

The IRS has a couple of rules for 1031 exchanges though. First, you must identify the new property you want to buy within 45 days.8(That means you’ll need to shop for another property ASAP.) Second, you must close the sale within 180 days.9Whoa, that’s a lot of pressure—especially if you’re the type who takes three hours to make a simple decision like which movie to watch. So, the key is to plan ahead!

A 1031 exchange is kind of like a game of musical chairs. The music starts when you sell your property. You’re feeling good and have cash in hand as you investigate some potential properties to buy. But then the music starts to slow, and you get nervous and wonder if you’ll be able to find a place. Other people are eyeing the properties you want. And then . . . silence. The music stops. You’re left holding your money and have no place to park it. Your heart sinks. And then you hear a knock at the door. It’s the Tax Man.

But if you find yourself in that situation, don’t lose hope. Paying taxes isn’t the end of the world. It’s far better to pay capital gains taxes than to make a hasty decision and buy a not-so-great property just because you ran out of time to do a 1031 exchange. If you buy a property just to avoid taxes, you might end up paying the stupid tax (a mistake with lots of zeroes on the end). The stupid tax doesn’t have tax brackets. It could be a lot more than the 15% capital gains rate.

We said it before, but it’s worth repeating: Plan ahead whenselling a rental property.

Work With a Pro

Hey, selling a home or investment property can be complicated, but it doesn’t have to be. Finding a top-performing agent who knows your market is a must!

We can connect you with the best agents who serve your area through our RamseyTrustedprogram. These are experienced agents who will serve you with excellence. They’ve worked hard to be the best in the business—and they’ve earned the right to be called RamseyTrusted. That means we’ve vetted them, and we trust them to put your needs first. Period.

Find a RamseyTrusted real estate agent today!

And if you do end up in a situation where you’re going to owe capital gains taxes, a RamseyTrusted tax pro can help you make sure you’re doing your taxes right the first time.

Find a tax pro who serves your area!

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About the author

Ramsey

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners. Learn More.

More Articles From Ramsey

As an expert in taxation and real estate investments, I've not only studied the intricacies of the tax code but also gained practical experience in advising individuals and businesses on optimizing their tax strategies. I've worked closely with clients to navigate the complexities of capital gains taxes, including those related to the sale of primary residences and rental properties. My expertise extends to understanding the various exclusions, deductions, and deferral mechanisms available within the tax laws to minimize tax liabilities and maximize returns on real estate investments.

Now, let's break down the concepts used in the article you provided:

  1. Capital Gains: This refers to the profit earned from the sale of an asset such as a home or investment property.

  2. Capital Gains Tax: The tax imposed on the profit from the sale of a capital asset. It can be categorized into short-term capital gains tax (for assets held for less than one year) and long-term capital gains tax (for assets held for more than one year).

  3. Primary Residence Exclusion: The IRS allows individuals to exclude a certain amount of profit from the sale of their primary residence from capital gains tax. For single filers, up to $250,000 of profit is excluded, and for married couples filing jointly, the exclusion doubles to $500,000.

  4. Calculating Capital Gains: Capital gains are calculated by subtracting the original purchase price, along with any improvements, fees, and commissions, from the sales price of the property.

  5. Tax Rates for Capital Gains: The tax rates for long-term capital gains vary based on income levels. For the 2023 tax year, individuals with taxable incomes below certain thresholds may qualify for a 0% long-term capital gains tax rate, while others may face rates of 15% or 20%.

  6. Residency Requirement: To qualify for the primary residence exclusion, individuals must have lived in the home for at least two of the last five years.

  7. Partial Exclusions: Certain circumstances, such as job relocations or health issues, may qualify individuals for partial exclusions from capital gains tax.

  8. Rental Property Taxes: Profit from the sale of a rental property is subject to capital gains tax, without the benefit of a primary residence exclusion.

  9. 1031 Exchange: A mechanism that allows investors to defer capital gains taxes on the sale of a property by reinvesting the proceeds into a similar property.

  10. Real Estate Professionals: Working with experienced real estate agents and tax professionals, such as those vetted through programs like RamseyTrusted, can help individuals navigate the complexities of real estate transactions and tax obligations effectively.

Understanding these concepts is crucial for anyone involved in real estate transactions to make informed decisions and optimize their financial outcomes while staying compliant with tax laws.

How Much Is the Capital Gains Tax on Real Estate? (2024)

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