Do I Pay Capital Gains When I Sell My House?
When you sell your house, you may be required to pay capital gains taxes on real estate profit you make from the sale. However, not all home sales are subject to capital gains taxes, and there are certain exemptions and deductions that can reduce or even eliminate the amount of tax owed.
In this guide, we will discuss what capital gains taxes are, how they apply to home sales, and ways to minimize or avoid tax on real estate sales, without illegally hiding your taxable income from the Internal Revenue Service.
What Are Capital Gains Taxes?
Capital gains taxes are a type of tax paid on the profits made from selling an asset that has increased in value since it was purchased. This could include stocks, bonds, real estate properties, and other investments.
The amount of long and short term capital gains tax owed is based on the difference between the purchase price and the selling price of the asset, also known as the capital gain or the taxable gain. The tax rate for capital gains can vary depending on your income level, tax filing status, and how long you have owned the asset. You can owe capital gains tax as soon as a year passes, in the case of long term capital gains. In the process of calculating capital gains tax incurred after selling your investment property, the owner's income tax bracket is not included, and their ordinary income tax is not affected.
Capital Gains Taxes on Home Sales
In most cases, when you sell your primary residence, any profit made from the sale is not subject to capital gains taxes. This is because of a special capital gains tax exclusion called the "primary residence exclusion" or "home sale exclusion".
Under this exclusion, if you have owned and lived in your home for at least two out of the past five years before selling it, you can exclude up to $250,000 of capital gains if you are single, or up to $500,000 if you are married filing jointly.
This means that if your profit from the sale of your home is less than the capital gains exclusion amount, you do not have to pay any capital gains taxes. However, if your profit exceeds the exclusion amount, then you will be required to pay capital gains taxes on the excess amount.
Exceptions and Special Circumstances
There are some exceptions and special circumstances where the primary residence exclusion may not apply and capital gains taxes may still be owed on a home sale. These include:
- If you have used a portion of your home for business purposes in the past five years before selling it
- If you have rented out your home for more than three years in the past five years before selling it
- If you have already used the primary residence exclusion within the past two years on a different property
- If you are subject to expatriation tax (for individuals who renounce their U.S. citizenship or long-term residency)
- If you sell a vacation home or rental property that is not your primary residence
It is important to consult with a tax professional if any of these exceptions apply to your situation, as they may affect the amount of capital gains taxes owed.
Tax Implications Of Selling To A Cash Buyer
Selling your house to a cash buyer can also have tax implications. If you sell your home to a cash buyer for less than its fair market value, the difference between the selling price and the fair market value may be considered a gift, and you may be subject to gift taxes.
Strategies for Minimizing or Avoiding Capital Gains Taxes on Home Sales
There are several strategies that homeowners can use to minimize or even avoid long term capital gains taxes on the sale of their home. These include:
- Making home improvements and keeping track of all expenses: Any money spent on home improvements can be added to the cost basis of your home, which can decrease your capital gain and potentially lower the amount of tax owed.
- Moving into a rental property before selling it: If you have rented out your primary residence for at least two years before selling it, you may still be able to claim the primary residence exclusion if you move back into the property for at least 24 months before selling it.
- Utilizing a 1031 exchange: This allows investors to defer paying capital gains taxes by reinvesting their profits in similar properties within a certain time frame.
- Gifting the property: If you gift your home to a family member or charitable organization, you can avoid paying capital gains taxes altogether. However, there may be gift tax implications to consider.
It is important to consult with a financial advisor or tax professional when considering these strategies to ensure they are in line with your financial goals and circumstances.