What is Capital Gains Tax on Real Estate? Capital gains tax is what you pay on an asset’s appreciation during the time that you have owned it. The capital gains tax can apply to any asset that increases in value. Most people encounter this tax when they sell their primary residence. The amount is depended on a few things. Here is any easy way to look at it:
You purchased your home for $400,000. You sold your home for $500,000. The difference between these two is $100,000. This is the capital gain and it’s subject to the tax.
The tax rate will depend on your current tax bracket, length time you owned the asset and if it is your primary residence or not. There are special rules that apply when it is a gifted or inherited property.
Short Term Capital Gains
If you purchased the asset less than a year ago, you’re dealing with a short-term capital gain or loss. This will be treated as ordinary income. There is no special tax considerations for capital gains made on short term investments. The government counts any gain you made on the home as standard income. House flippers are a good example of those who deal with short term capital gains. You can help minimize the tax burden by carefully accounting for all your expenses and deductions.
Long Term Capital Gains
If you purchased the asset more than a year ago, you’re dealing with long-term capital gain, which gives preferential tax treatment and if it’s your primary resident, may even be exempt (Taxpayer Relief Act of 1997). On a primary residence, single people can exclude up to $250,000 of gain, and married people filing a joint return can exclude up to $500,000 of the gain. This rule also allows you to convert a rental property into a personal residence because of the 24 month residency requirement does not need to be fulfilled in consecutive years, just cumulative months.
A major restriction is that you can only benefit from this exemption once every two years. Therefore, if you have more than one home and have lived in each for at least two of the last give years, you won’t be able to sell both of them tax free until more than two pears have passed since you sold the first property.
Here are a few situations that gains from a home sale are fully taxable:
- Property was acquired through a 1031 exchange within 5 years
- Seller is subject to expatriate taxes
- Home is not the seller’s principal residence
- Seller sold another home within two years from the date of the sale and used the capital gains exclusion for that sale
- Property was not owned and used as the seller’s principal residence for at least two of the last give years prior to the sale.
Want to lower your tax bill on the sale of your home? There are ways to reduce what you owe or avoid taxes on the sale of your property. Adjustments to the cost basis can help reduce the gain, Your cost basis can be increased by including fees and expenses associated with the purchase of the home, home improvements and additions. The resulting increase in the cost basis thereby reduces the capital gains. Capital losses from other investments can be used to offset the capital gains from the sale of your home. Larger losses can even be carried forward to subsequent tax years.
Taxes on capital gains can be substantial. Fortunately, the Taxpayer Relief Act of 1997 provides some relief to homeowners who meet certain IRS criteria. For single tax filers, up to $250,000 of the capital gains can be excluded, and for married tax filers filing jointly, up to $500,000 of the capital gains can be excluded. For gains exceeding these thresholds, capital gains rates are applied. There are exceptions for certain situations, such as divorce and military deployment, as well as rules for when sales must be reported. Understanding the tax rules and staying abreast of tax changes can help you better prepare for the sale of your home.
Make sure to reach out to your CPA prior to selling any asset to find out if you will need to pay capital gains. This information is a guideline and you should always speak to a CPA before selling.