A couple stands outside a home with a for sale sign in the yard, with their relator.

Capital Gains Taxes And The Sale Of Your Home Or Investment Property

6-minute read

September 08, 2021

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There are many tax considerations for homeowners. Taxes related to real estate are paid from the time you buy the home all the way through the sale of your property.

Capital gains tax may not be the most exciting part of selling your home, but it’s important to know how it’ll impact your sale. We’re going to teach you a little bit more about the capital gains tax, what it means and how you can reduce your tax burden when you sell your home.

What Is The Capital Gains Tax?

The capital gains tax is what you pay on an asset’s appreciation during the time that you owned it. The amount of the tax depends on your income, your tax filing status and the length of time that you owned the asset.

The capital gains tax can apply to any asset that increases in value. Most people encounter this tax when they sell their primary residences.

How Does The Capital Gains Tax Work?

Let’s start by giving you a feel for how the tax works.

For example, let’s say you bought your home for $150,000 and you sold it for $200,000. Your profit, $50,000 (the difference between the two prices), is your capital gain – and it’s subject to the tax.

You only pay the capital gains tax after you sell an asset. Let’s say you bought your home 2 years ago and it’s increased in value by $10,000. You don’t need to pay the tax until you sell the home.

In this example, your home’s purchase price is your cost basis in the property. Let’s expand on that by assuming you spent $50,000 on a kitchen renovation. That’s a capital improvement, so your cost basis is now $200,000. That’s $150,000 (the original purchase price) + $50,000 (the amount spent on the capital improvement). If you sell your home after the renovation for $200,000, your profit is $0, so there’s no capital gains tax.

What Is The Capital Gains Tax Rate?

Your capital gains tax rate will depend on your current tax bracket, the length of time you’ve held the asset and whether the property was your primary residence. We’ll look at that below. 

It’s also important to know the type of asset you’re dealing with, because while most long-term capital gains are taxed at rates of up to 20% based on income, there are situations in which higher rates apply. These assets include:

Special Asset Classes For Long-Term Capital Gains Tax

Asset Type

Capital Gains Tax Rate

Taxable part of gain from qualified small business stock sale under section 1202

28%

Collectibles (such as art, coins, comics)

 

28%

Unrecaptured gain under section 1250 for real property (applies in certain cases where depreciation was previously reported)

25%

 

There are special rules that apply for gifts of property or inherited property, patents or certain types of investment income like commodity futures. For tax purposes, these dates are calculated from the day after the original purchase to the date of sale of the property.

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Short-Term Vs. Long-Term Capital Gains Tax

When you start to think about selling a capital asset for a gain or a loss, the first thing you need to ask yourself is “When did I buy this?” If it was less than a year ago, you’re dealing with a short-term capital gain or loss, and it will be treated as ordinary income. If it’s more than a year, that’s a long-term capital gain, which will be given preferential tax treatment, and – if it’s your primary residence – may even be exempted.

However, there are exceptions for property that is a gift or an inheritance.

Short-Term Capital Gains Tax

If you’ve made the determination based on the rules mentioned above that short-term capital gains tax applies in your situation, the profit is taxed at regular income tax rates. For the 2021 tax year, these rates are as follows:

Short-Term Capital Gains Tax Rates

Tax Rate

Single

Married Filing Jointly and Surviving Spouses

Married Filing Separately

Head of Household

10%

$0 – $9,950

$0 – $19,900

$0 – $9,950

$0 – $14,200

12%

$9,951 – $40,525

$19,901 – $81,050

$9,951 – $40,525

$14,201 – $54,200

22%

$40,526 – $86,375

$81,051 – $172,750

$40,526 – $86,375

$54,201 – $86,350

24%

$86,376 – $164,925

$172,751 – $329,850

$86,376 – $164,925

$86,351 – $164,900

32%

$164,926 – $209,425

$329,851 – $418,850

$164,926 – $209,425

$164,901 – $209,400

35%

$209,426 – $523,600

$418,851 – $628,300

$209,426 – $314,150

$209,401 – $523,600

37%

$523,601 or more

$628,301 or more

$314,151 or more

$523,601 or more

 

Tax rates work slightly differently if you happen to be declaring a short-term capital gain sold by an estate or trust.

Short-Term Capital Gains for Estates or Trusts

Tax Rate

Estate or Trust Income

10%

$0 – $2,650

24%

$2,650 – $9,550

35%

$9,550 – $13,050

37%

Over $13,050

 

Your home is considered a short-term investment if you own it for less than a year before you sell it. There are no special tax considerations for capital gains made on short-term investments. Instead, the government counts any gain you made on the home as part of your standard income.

This can present a major problem for short-term buyers like house flippers. For example, let’s say you earn a profit of $50,000 from flipping a home within 1 year. Let’s also say that you earn an annual salary of $50,000 from your regular job. Under these circumstances, the $50,000 you earned from the sale of your home essentially doubles your income. When you file your federal taxes, the IRS would consider your gross income for that year to be $100,000 and you’d be subject to the same tax rate as an executive that earns $100,000 at your company.

You can minimize your tax burdens with short-term sales by carefully accounting for all of your expenses and deductions.

Long-Term Capital Gains Tax

Owning your home for more than a year means you pay the long-term capital gains tax. After 2 years, you’ll qualify for the personal exemption – more on that below. Unlike the seven short-term federal tax brackets, there are only three capital gains tax brackets. The long-term capital gains tax rates are much lower than the corresponding tax rates for standard income. You may not need to pay the tax at all if you make less than the minimum amount listed below.

The percentage you pay on your capital gains depends on your filing status and how much money you made last year.

Long-Term Capital Gains Tax Rates

Filing Status

0%

15%

20%

Single

Up to $40,400

$40,401 – $445,850

Over $445,850

Married Filing Jointly and Surviving Spouse

Up to $80,800

$80,801 – $501,600         

Over $501,600

Married Filing Separately

Up to $40,400

$40,401 – $250,800

Over $250,800

Head of Household

Up to $54,100

$54,101 – $473,750

More than $461,700

Trusts and Estates

Up to $2700

$2,701 – $13,249

More than $13,250

What About Capital Gains Taxes On An Investment Property?

You can minimize your burden by selling the home strategically if you have an investment property. The capital gains exemption on homes does not have a counterpart in the investment property realm.

Reinvest Sale Proceeds

Many real estate investors engage in 1031 (like-kind) exchanges. In a 1031 exchange, a real estate investor sells their current property but then rolls the proceeds into a new investment opportunity and postpones his capital gains taxes indefinitely.

Another alternative available to longtime real estate investors with large capital gains tax liabilities is to transfer those assets into an opportunity zone. Investors begin to enjoy a step up in basis after 5 years. After 10 years, the gains become tax-free.

Offset Capital Gains With Capital Losses

Just as individual homeowners might choose to sell their home when their income is at a low ebb, businesses should offset capital gains with capital losses.

Deduct The Costs Incurred By The Sale

You can also deduct any repairs or renovations you made to an investment property to improve the final selling price of the home. Remember to keep documentation such as bills, deeds of sale, credit card statements and other similar papers to prove how much you spent. These documents will be an asset if you’re audited.

The Bottom Line: Capital Gains Taxes Can Be Avoided By Some Homeowners And Investors

No matter which type of property you decide to sell, take careful note of how much money you spend finding and securing a buyer. From marketing expenses to closing costs paid by the seller (like real estate agent fees), you can deduct these costs from your taxes.

Looking for other real estate tax tips? Learn more about the top tax benefits of real estate.

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