- Capital Gains Tax On A Home Sale
Capital Gains Tax On A Home Sale: What You Need To Know
Capital gains taxes may not be the most exciting part of selling your home, but it’s important to know how they’ll impact your sale. When you earn money selling an asset, you must pay capital gains taxes. This means that you might have to pay in taxes a large percentage of the amount you gained on the sale if you sell your home.
There are a few ways you can reduce what you owe. 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 a tax you pay when you sell an asset that has increased in value since you bought it. For example, let’s say you bought your home for $150,000 and you sold it for $180,000. $30,000, or the difference between the two selling prices, is your capital gain and it’s subject to the capital gains tax. Your capital gains tax rate can be 0%, 10% or 20% depending on your income and your tax filing status.
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.
There are two main types of capital gains: short-term and long-term. Below, we’ll go over the differences between the two.
How To Avoid The Capital Gains Tax
There are a few ways that homeowners can avoid the capital gains tax when they sell their house. The first is through an exemption. An exemption means you don’t need to pay taxes even if your home has increased in value since you bought it. Here are a few situations in which you’d be exempt from paying the tax:
Learn Whether You Can Deduct From The Capital Gains Tax
You don’t need to pay up to $250,000 ($500,000 for married couples filing jointly) in capital gains on your home sale if you meet three conditions:
- You’ve lived in your home for the last 2 years. You can only deduct capital gains on your primary residence. You must have lived in your home for at least 2 years out of the last 5 years before you sell it to qualify for an exemption. The years you’ve lived in the home don’t have to be consecutive.
- You’ve owned your home for at least 2 years. You need to have owned your home for at least 2 years before you can claim an exemption. If you haven’t owned your home for at least 2 years, you’ll pay the much more expensive short-term tax rate.
- You haven’t recently claimed another exemption. You can’t claim another exemption if you’ve already claimed an exemption during the last 2 years.
Understand What You Can Deduct From The Capital Gains Tax
You’re exempt from paying the capital gains tax up to a certain extent if you meet the above criteria. If you file under the “single” status, you can deduct up to $250,000 worth of capital gains. If you’re “married filing jointly,” you can deduct up to $500,000 worth of capital gains.
The government taxes capital gains at different rates than regular income. This is a major benefit for home sellers because there are only three brackets of capital gains taxes. If you file as a single person and you earned less than $39,375 that year, you don’t need to pay the tax. If you’re married and you file jointly, you can earn up to $78,750 total before you need to pay.
Keep in mind that these numbers only apply to the long-term capital gains tax. Your home must have been in your possession for at least a year before you sell it to take advantage of these deductions.
Short-Term Vs. Long-Term Capital Gains Tax: What’s The Difference?
If you do need to pay the capital gains tax, it’s important to know the date you bought and sold the home. This is because there are different tax strategies for long-term and short-term investments:
Short-Term Capital Gains Tax
Your home is considered a short-term investment if you own your home 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. 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. If you’re single, you’ll pay:
- Up to $39,375 in income: 0%
- Between $39,376 to $434,550: 15%
- $434,551 or more: 20%
If you’re married and you file jointly, you’ll pay:
- Up to $78,750 in income: 0%
- Between $78,751 to $488,850: 15%
- $488,851 or more: 20%
Tips For Paying Little To No Capital Gains Tax
There are a few ways that you can minimize (or even eliminate) your capital gains tax liability. Use these tips to reduce the amount that you owe:
Live In Your Home For At Least 2 Years
You need to live in your home for at least 2 years out of the last 5 years to qualify it as a primary residence. The 2 years that you live in your home don’t need to be consecutive. You also don’t need to own your home for at least 5 years in order to claim an exemption from the capital gains tax. For example, if you own your home for 3 years and live in it for 2 years before you sell it, it’s still considered a primary residence. In a case like this, you wouldn’t need to pay the capital gains tax when you sell the home.
Sell The Home When Your Income Dips
You can minimize your burden by selling the home strategically if you have an investment property that’s not exempt from the capital gains tax. Keeping careful track of how much money you made can help you find the best time to sell your home.
For example, let’s say that you and your spouse earn a combined $80,000 a year. Then, let’s say that your spouse has a baby and leaves her job to care for the baby full time, and as a result your household income drops to $50,000. This would be the ideal time to sell the home because your new income puts you in the 0% bracket for capital gains, thereby eliminating your liability.
Keep Track Of Your Expenses
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.
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 capital gains tax is a levy you pay on assets that you sell for more money than you paid for them. You pay the short-term capital gains tax if you own your asset for less than a year. The government classifies short-term gains as a part of your standard income. If you own your home for more than a year, you’ll pay reduced rates with the long-term capital gains tax.
There are a number of exemptions that you can use to avoid the tax. You don’t need to pay at all if your income is below the threshold. You also don’t need to pay on up to $250,000 worth of gain when you sell your primary residence. For married couples, that exempt gain doubles to $500,000. It’s a good idea to live in your property strategically and record all of your expenses in order to minimize your tax liability.
In conclusion, the amount you’ll pay in taxes depends on valid deductions, your income and the amount that you sell your asset for. Remember, everyone’s financial situation is different and it’s best to speak with a licensed financial expert or advisor before making any major financial decisions.
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