What Is Capital Gains Tax on Real Estate? (2024)

Capital gains tax is the income tax you pay on gains from selling capital assets—including real estate. So if you have sold or are selling a house, what does this mean for you?

If you sell your home for more than what you paid for it, that’s good news. The downside, however, is that you probably have a capital gain. And you may have to pay taxes on your capital gain in the form of capital gains tax.

Just as you pay income tax and sales tax, gains from your home sale are subject to taxation.

Complicating matters is the Tax Cuts and Jobs Act, which took effect in 2018 and changed the rules somewhat. Here’s what you need to know about all things capital gains.

Who pays capital gains tax?

In a nutshell, capital gains tax is a tax levied on possessions and property—including your home—that you sell for a profit.

If you sell it in one year or less, you have a short-term capital gain.

If you sell the home after you hold it for longer than one year, you have a long-term capital gain. Unlike short-term gains, long-term gains are subject to preferential capital gains tax rates.

The primary residence tax exemption

Unlike other investments, home sale profits benefit from capital gains exemptions that you might qualify for under some conditions, says Kyle White, an agent with Re/Max Advantage Plus in Minneapolis–St. Paul, MN.

The IRS gives each person, no matter how much that person earns, a $250,000 tax-free exemption on capital gains from a primary residence. You can exclude this capital gain from your income permanently.

“So if you and your spouse buy your home for $100,000, and years later sell for up to $600,000, you won’t owe anycapital gainstax,” saysNew York attorneyAnthony S. Park.However, you do have to meet specific requirements to claim this capital gains exemption:

  • The home must be your primary residence.
  • You must have owned it for at least two years.
  • You must have lived in it for at least two of the past five years.
  • You cannot have taken this exclusion in the past two years.

If you don’t meet all of these requirements, you may be able to take a partial exclusion for capital gains tax if you meet certain exceptions (e.g., if your job forces you to move before you live in the home two years). For more information, consult a tax adviser or the IRS.

What’s my capital gains tax rate?

For capital gains over that $250,000-per-person exemption, just how much tax will Uncle Sam take out of your long-term real estate sale? Long-term capital gains tax rates are based on your income (pre-2018 it was based on tax brackets), explains Park.

Let’s break it down.

For single folks, you can benefit from the 0% capital gains rate if you have an income below $44,625 in 2023. Most single people will fall into the 15% capital gains rate, which applies to incomes between $44,626 and $492,300. Single filers with incomes more than $492,300, will get hit with a 20% long-term capital gains rate.

The brackets are a little bigger for married couples filing jointly, but most will get hit with the marriage tax penalty here. Married couples with incomes of $89,250 or less remain in the 0% bracket, which is great news. However, married couples who earn between $89,251 and $553,850 will have a capital gains rate of 15%. Those with incomes above $553,850 will find themselves getting hit with a 20% long-term capital gains rate.

  • Your tax rate is 0% on long-term capital gains ifyou’re a single filer earning less than $44,625, married filing jointly earning less than $89,250, or head of household earning less than $59,750.
  • Your tax rate is 15% on long-term capital gains if you’re a single filer earning between $44,626 to $492,300, married filing jointly earning between $89,251 to $553,850, or head of household earning between $59,751 to $523,050.
  • Your tax rate is 20% on long-term capital gains ifyou’re a single filer earning more than $492,300, married filing jointly earning more than $553,850, or head of household earning $523,050 or more.

Don’t forget, your state may have its own tax on income from capital gains. And very high-income taxpayers may pay a higher effective tax rate because of an additional 3.8% net investment income tax.

If you held the property for one year or less, it’s a short-term gain. You pay ordinary income tax rates on your short-term capital gains. That’s the same income tax rates you would pay on other ordinary income such as wages.

Do renovations reduce capital gains?

You can also reduce the amount of capital gains subject to capital gains tax by the cost of home improvements you’ve made. You can add the amount of money you spent on anyhome improvements—such as replacing the roof, building a deck, replacing the flooring, or finishing a basem*nt—to the initial price of your home to give you the adjusted cost basis. The higher your adjusted cost basis, the lower your capital gain when you sell the home.

For example: if you purchased your home for $200,000 in 1990 and sold it for $550,000, but over the past three decades have spent $100,000 on home improvements. That $100,000 would be subtracted from the sales price of your home this year. Instead of owing capital gains taxes on the $350,000 profit from the sale, you would owe taxes on $250,000. In that case, you’d meet the requirements for a capital gains tax exclusion and owe nothing.

Take-home lesson: Make sure to save receipts of any renovations, since they can help reduce your taxable income when you sell your home. However, keep in mind that these must be home improvements. You can’t take a deduction from income for ordinary repairs and maintenance on your house.

Capital gains on inherited homes

What if you’re selling a home you’ve inherited from family members who’ve died? The IRS also gives a “free step-up in basis” when you inherit a family house. But what does that mean?

Let’s say Mom and Dad bought the family home years ago for $100,000, and it’s worth $1 million when it’s left to you. When you sell, your purchase price (or “basis”) is not the $100,000 your folks paid, but instead the $1 million it’s worth on the last parent’s date of death.

You pay capital gains tax only on the difference between what you sell the house for, and the amount it was worth when your last parent died.

What if my home sells at a loss?

If you sell your personal residence for less money than you paid for it, you can’t take a deduction for the capital loss. It’s considered to be a personal loss, and a capital loss from the sale of your residence does not reduce your income subject to tax.

If you sell other real estate at a loss, however, you can take a tax loss on your income tax return. The amount of loss you can use to offset other taxable income in one year may be limited.

How investors avoid capital gains tax

If the home you’re selling is not your primary residence but rather an investment property you’ve flipped or rented out,avoiding capital gains tax is a bit more complicated. But it’s still possible. The best way to avoid a capital gains tax if you’re an investor is by swapping “like-kind” properties with a 1031 exchange.This allows you to sell your property and buy another one without recognizing any potential gain in the tax year of sale.

“In essence, you’re swapping one investment asset for another,” says White. He cautions, however, that there are very strict rules regarding timelines and guidelines with this transaction, so be sure to check them with an accountant.

If you’re opting out of therentalproperty investment business and putting your money in another venture that does not qualify for the 1031 exchange, then you’ll owe the capital gains tax on the profit.

I am an expert in real estate and tax matters, and I can confidently provide insights into the complex world of capital gains tax associated with the sale of real estate. My expertise is grounded in a deep understanding of the relevant laws, regulations, and practical implications of these transactions.

Now, let's delve into the concepts presented in the article:

Capital Gains Tax Overview:

Capital gains tax is the income tax imposed on profits derived from the sale of capital assets, including real estate. It applies when the selling price exceeds the original purchase price.

Short-Term vs. Long-Term Capital Gains:

  • Short-term capital gains result from selling the property within one year, while long-term gains stem from holding the property for more than one year.
  • Long-term gains often enjoy preferential tax rates compared to short-term gains.

Primary Residence Tax Exemption:

  • The IRS offers a $250,000 tax-free exemption on capital gains for each person from the sale of a primary residence.
  • Eligibility criteria include owning the home for at least two years, living in it for at least two of the past five years, and not having claimed the exclusion in the past two years.

Capital Gains Tax Rates:

  • Tax rates for long-term capital gains depend on income levels.
  • Rates can be 0%, 15%, or 20%, with specific thresholds for single filers and married couples filing jointly.

Impact of Home Improvements:

  • Costs of home improvements, such as renovations or additions, can be added to the initial purchase price to reduce the capital gain when selling.
  • This adjusted cost basis helps minimize the taxable income from the sale.

Inherited Homes and Step-Up in Basis:

  • Inherited homes benefit from a "free step-up in basis," meaning the purchase price for tax purposes is adjusted to the property's value at the time of the last parent's death.

Selling at a Loss:

  • Selling a personal residence at a loss does not allow for a deduction, as it is considered a personal loss.
  • However, losses from selling other real estate may be deductible, subject to certain limitations.

Avoiding Capital Gains Tax for Investors:

  • Investors can use a 1031 exchange to defer capital gains tax by swapping one investment property for another.
  • Strict rules and timelines apply to 1031 exchanges.

As an enthusiast in this field, I encourage individuals navigating real estate transactions to consult with tax advisers or legal professionals to ensure compliance with ever-evolving tax laws.

What Is Capital Gains Tax on Real Estate? (2024)

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