If you’re looking to sell your home and it has increased in value during your ownership, the sale may be subject to a capital gains tax. There are a few ways to avoid this tax so that you can keep as much profit as possible.
Capital Gains Tax Defined
You are required to pay capital gains when you sell an asset for more than you paid for it. Any gain must be reported to the IRS when filing your income taxes. It’s important to note that taxes are only due upon the sale of the asset, and not during the period of ownership. Once you sell an asset, capital gains become “realized gains”, but during the ownership period, they are “unrealized gains.”
Calculating Capital Gains Tax
Calculating capital gains tax on the sale of a home can be complex and depends on a variety of factors, including tax bracket, marital status, how long you’ve owned the home, and whether it is a primary residence. If you sell your house in less than one year of owning it, the short-term capital gains is taxed as ordinary income, which could be as high as 37%. Long-term capital gains for properties owned over a year are taxed at either 15% or 20% depending on your income bracket.
The tax is assessed on the profit only. As an example, if you purchased your home 5 years ago for $500,000 and sold it today for $600,000, you would need to report the home sale and potentially pay a capital gains tax on the $100,000 profit.
So are there any ways to get around this tax? The answer is maybe. The IRS gives you a tax break if you meet certain conditions.
If you are single, you will pay no capital gains tax on the first $250,000 of profit. If you are married, that number increases to $500,000. To be exempt, the home must also be considered a primary residence based on IRS rules, which means that you must have owned the home for at least two years and occupied the residence for at least two of the last five years (but these years do not have to be consecutive). It’s important to note that this exemption is only allowed once every two years. So, if you have two homes and have lived in both for at least two of the last five years, you won’t be able to sell both of them without paying the capital gains tax.
If you still have capital gains after taking advantage of the exemptions, you may be able to lower the amount of taxable profit by deducting certain expenses. These expenses may include the cost of repairs, improvements and upgrades, and closing costs from the property sale.
If you’re interested in selling your home, make sure to talk to an accountant about the potential for any capital gains tax and whether you may be eligible for any exemptions or deductions.
If your home is an investment property, you may also be eligible for a 1031 exchange.