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Capital gains tax on Home Sale

capital gains tax

In this article, you will learn

  • How can I avoid paying capital gains tax on the sale of my home?
  • How Much Does Real Estate Capital Gains Tax Cost?
  • How Does the Capital Gains Tax Affect Homes?
  • When Is a Home Sale Taxable in Its Entirety?
  • How to Sell a House Without Paying Capital Gains Tax
  • Make Your Second House Your Primary Residence
  • How Installment Sales Help You Save Money on Taxes
  • How Do Property Taxes Work?

How can I avoid paying capital gains tax on the sale of my home?

All of the tedious efforts you took—countless property searches, contract discussions, inspections, and closing—to reach the dream of homeownership are likely to be your life’s most significant and most exemplary buy. It’s time to put your house on the market. So, where do we go from here? Are you aware that your home is considered a capital asset subject to capital gains tax? If the value of your home has grown, you may be liable for more taxes.

Most homes, however, are exempt, thanks to the Taxpayer Relief Act of 1997.

If you are single, you won’t have to pay capital gains tax on the first $250,000 you earn (excess over cost basis). Married couples are eligible for a $500,000 exemption. There are, however, some limitations.

How Much Does Real Estate Capital Gains Tax Cost?

The home must be considered a primary residence under IRS guidelines to qualify for the exemption. According to these criteria, you must have lived in the house for at least two of the previous five years.

You will be subject to capital gains tax if you purchase a home and then sell it after it has appreciated significantly in value. If the profit exceeds IRS standards and you’ve owned your home for at least two years and meet the primary dwelling requirements, you may owe tax on the profit. Individuals can deduct up to $250,000. Married people filing jointly are eligible for a deduction of up to $500,000.

Because the two-year residency requirement does not have to be accomplished consecutively, this legislation allows you to convert the rental property into your primary residence.

How Does the Capital Gains Tax Affect Homes?

Let’s say you spend $300,000 on a new condo. You live there for the first year, then rent it for the next three years, and then move back in after the renters leave. You sell the condo for $450,000 after five years. Because the profit ($450,000 – $300,000 = $150,000) doesn’t exceed the exclusion level, no capital gains tax is due. Consider an alternative conclusion in which your neighborhood’s home values skyrocketed.

You sell the condo for $600,000 in this case. $50,000 is subject to capital gains tax ($300,000 earnings minus $250,000 IRS exception). As a single individual, your capital gains tax rate in 2021 will be 15% of your income which is between $40,400 and $441,450. (In 2022, the income range improves slightly, to $41,675 to $459,750.) If you have other capital losses, you can use them to offset the capital gains from the sale of the residence, as well as up to $3,000 in other taxable income.

Conditions and Limitations: If you meet the IRS’s eligibility requirements, you may sell your home tax-free. However, there are several exceptions to the eligibility requirements detailed on the IRS website.

The vital stipulation is that you can only use this exemption every two years. As a result, if you own two properties and have resided in both for at least two of the previous five years, you will not be able to sell them both tax-free.

When Is a Home Sale Taxable in Its Entirety?

Capital gains exemptions are not available to all taxpayers. Gains on the sale of a primary residence are fully taxable if the following conditions are met:

  • The seller is taxed on an expatriate basis.
  • For at least two of the five years preceding the sale, the seller did not own and utilize the property as his primary residence (some exceptions apply)
  • Within two years after the sale, the seller sold another home and took advantage of the capital gains exclusion on that sale.

Example of Capital Gains Tax on a Home Sale

Consider the following example. Susan and Robert, a married couple, purchased their home in 2015 for $500,000. Their neighborhood grew exponentially, and the value of their homes increased dramatically. They sold their home for $1.2 million in 2020, capitalizing on the rise in home values. Capital gains of $700,000 were realized as a result of the sale.

As a married couple filing jointly, they can exclude $500,000 of capital gains, leaving $200,000 subject to capital gains tax. Their combined income is sufficient to place them in the 20% tax bracket. As a result, they owed a capital gains tax of $40,000.

How to Sell a House Without Paying Capital Gains Tax

Do you want to minimize your tax liability when you sell your home? There are strategies to reduce your debt or avoid paying capital gains taxes on the sale of your house. If you own your house and have lived in it for two of the last five years, you can deduct up to $250,000 in gain ($500,000 for married couples filing jointly).

Adjusting the cost base may also help to reduce the gain. To increase your cost basis, including fees and expenses associated with the purchase of the home, as well as home improvements and extensions. Capital gains are lowered as a result of the increased cost basis.

Additionally, you can utilize capital losses from other assets to offset capital gains from the sale of your property. Significant losses can even be carried forward to the following year’s taxes. Let’s look at other options for lowering or avoiding capital gains taxes on property sales.

Make Your Second House Your Primary Residence

Many homeowners find capital gains exemptions attractive, to the extent where they may wish to maximize its use over their lives. Due to the fact that non-principal residences and rental properties do not qualify for the same capital gains tax exemptions as primary residences, more people have sought imaginative ways to reduce their capital gains tax on property transactions. One way is to convert a second home or rental property into a primary residence.

Prior to selling, homeowners may utilize their second property as their primary residence for a period of two years to qualify for the IRS capital gains tax exemption. However, there are certain limitations. The exclusion does not apply to depreciation deductions on gains realized prior to May 6, 1997.

According to the 2008 Housing Assistance Tax Act, a rental property converted to a primary residence is only eligible for the capital gains exclusion during the time the property was used as a primary residence.

The capital gains are spread out across the entire ownership tenure. The allocated portion of the property falls under non-qualifying use and is not eligible for the exclusion while being used as a rental property.

To prevent anyone from abusing the 1031 exchange and capital gains exclusion, the American Jobs Creation Act of 2004 requires that the swapped property be kept for at least five years following the transaction.

How Installment Sales Help You Save Money on Taxes

The goal is to generate a huge profit on investment by selling it. On the other hand, the matching tax on the sale may not be. There is a way to alleviate the tax load on landlords and second homeowners. By delaying a portion of the gain over time, the property owner can reduce taxable income. Over the contract’s stated term, a particular payment is generated.

Each payment comprises three components: principal, gain, and interest, with the principal representing the non-taxable cost basis and the interest being taxed as ordinary income. The tax on a fractional portion of the gain will be lower than a lump-sum gain return. Long-term or short-term capital gains are taxed differently depending on how long the property owner owned it.

How Do Property Taxes Work?

Most purchases are taxed based on the cost of the item being purchased. The same can be said about real estate. State and local governments impose real estate or property taxes on real estate; the funds raised are used to fund public services, projects, and schools, among other things.

Gains on Investments Investment Property Taxes

There are various sorts of real estate. It’s usually categorized as a rental property, an investment, or a primary residence. The primary location in which an owner’s life is referred to as their principal residence is real estate. A rental or investment property is real estate that has been acquired or repurposed in order to create revenue or profit for the owner(s) or investor (s).

Property categorization has an effect on how it is taxed and what tax deductions, such as mortgage interest deductions, may be claimed. Mortgage interest on a residential house is deductible up to $750,000 under the Tax Cuts and Jobs Act of 2017. A professional A property utilized purely as an investment property, on the other hand, does not qualify for the capital gains exclusion. 

The 1031 exchange allows capital gains tax deferrals for investment properties if the funds from the sale are utilized to purchase a like-kind investment. Capital losses from the previous tax year can be used to offset capital gains from the sale of investment properties. Although investment properties are not eligible for the capital gains exclusion, there are strategies to decrease or eliminate capital gains taxes.

Vacation Home vs. Rental Property

Rental properties are rented out to others to earn revenue or profit. A vacation home is a real estate utilized for recreational purposes rather than as a primary dwelling. It is generally used for holidays and short-term stays.

When they are not using their vacation houses, they frequently convert them to rental properties. The rental money can pay off the mortgage and other upkeep costs. However, there are a few factors to keep in mind. The income from a vacation house rented for fewer than 15 days is not taxable. It is termed an investment property if the owner utilizes the vacation house for fewer than two weeks a year and then rents out for the rest.

If you meet the IRS ownership and use standards, you can benefit from the capital gains tax exclusion when selling your holiday home.

Property taxes vs. real estate taxes

The phrases real estate and property and real estate taxes and property taxes are frequently interchanged. On the other hand, the property is a broad phrase that refers to various assets, including real estate, and not all properties are taxed equally.

Property taxes are ad-valorem taxes levied by the state and local governments where the real estate is located on a per-square-foot basis. The real estate property tax is computed by multiplying the property tax rate by the market value of the real estate (e.g., houses, condos, and buildings) and the land on which it resides.

Property taxes are levied on movable property in the context of personal property. Personal property tax does not apply to real estate, which is immovable. Automobiles, watercraft, and heavy equipment are examples of private property. Property taxes are imposed at the state or local level, and they differ from one state to the next.

Final Thoughts

Capital gains taxes can be relatively high. Fortunately, the Taxpayer Assistance Act of 1997 gives some relief to homeowners who meet specific IRS requirements. The capital gains of single taxpayers can be excluded up to $250,000, and the capital gains of married taxpayers filing jointly can be subtracted up to $500,000. Capital gains rates are applied to gains that surpass these limits.

There are some exceptions, such as divorce and military deployment, and there are guidelines for disclosing sales. Understanding tax laws and keeping up with tax changes may help you prepare to sell your home.

Is it true that home sales are tax-free?

If the condition of the sale meets specific criteria, it is tax-free. The seller must have owned the house for at least two of the last five years and utilized it as their primary residence. To qualify, the two years must not be consecutive. The seller can’t have sold a residence in the last two years to qualify for the capital gains tax break. If the seller’s gains do not reach the exclusion threshold ($250,000 for single taxpayers and $500,000 for married taxpayers filing jointly), the seller does not owe taxes on the sale of their house.

When I sell my house, how can I avoid paying taxes?

You can avoid paying taxes on selling your home in many ways. Here are a few examples:

  • Balance out your financial gains and losses. The previous year’s capital losses can be carried forward to offset gains in subsequent years.
  • Take advantage of the IRS primary residence exclusion. You can exclude up to $250,000 of capital gains if you’re a single taxpayer and up to $500,000 if you’re married and filing jointly (certain restrictions apply).
  • Additionally, a 1031 exchange allows you to reinvest the proceeds from the sale of a rental or investment property within 180 days.

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