With property values continuing to climb in most cities across the U.S., you may be planning to sell your home or rental property. If that is the case, you may be wondering if you will have to pay taxes to the I.R.S. on any profits you receive on the home sale. Whether you owe taxes will depend on many factors, including whether you lived in the house and reinvesting your profits into another home.
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What Is Capital Gains Tax?
Capital gains tax is what you pay when you sell an asset that has increased value while owning it. Capital gains taxes are levied on significant assets, such as real estate, vehicles, stocks, bonds, valuable collectibles and artwork. The ‘capital’ is the money you invested in the first place, and the ‘gains’ are any profits when you sell.
In this case, the asset is your home, and the I.R.S. will collect taxes on the income you earn from selling it. Your capital gains tax liability will depend on:
- Whether the home is your primary residence
- How much profit you make from the sale
- How long you have owned the house, second home or rental property
Holding Property Long-Term Vs. Short-Term
The taxes you may owe on the sale of assets like your house or rental property will be determined in part by how long you owned it. For example, short-term capital gains on property you have owned for less than one year would be owed at your current taxable income rate, while long-term capital gains taxes would be due on profits on an investment owned for longer than a year.
Capital Gains Tax Rates
Your property’s capital gains tax rate will depend on how the house is used. If it is your primary residence, you may not be taxed on the profit of the home sale. This is due to the primary residence exclusion for capital gains taxes. Single taxpayers can exclude up to $250,000 of profit when you sell the house you live in. The capital gains tax exclusion for married couples filing jointly is $500,000.
If the home you intend to sell is a rental property or your vacation home, the capital gains tax you will pay depends on how long you own the house.
Short-Term Capital Gains Tax
A house that is not your primary residence and you have owned for less than one year when it is sold will be subject to short-term capital gains tax. That means it will be taxed with your other ordinary income for that tax year. Current tax brackets range from a minimum of 10% up to the maximum of 37%.
Long-Term Capital Gains Tax
Your tax liability will be at a lower rate if you sell a second home or rental property you have owned for more than one year. Long-term capital gains are taxed at 0%, 15% or 20%. Your rate would depend on your taxable income and your filing status.
What Is Property Tax Basis?
Property tax basis is the amount your house or rental property is worth for tax purposes. It is not simply the difference between how much you sell it for and the amount you originally paid for it. Instead, the gain or loss for tax purposes is calculated by subtracting realtor commissions, closing costs, and the costs of any property renovations you completed from the original purchase price and deducting costs associated with selling it, such as commissions and advertising, from the sales price.
Submit an online application form to inquire about Angel Oak Mortgage Solutions financing options.
Buy a home or refinance your existing mortgage with Zero Mortgage.
Older homeowners can get peace of mind and added financial security with a reverse mortgage from AAG.
How To Avoid Capital Gains Tax On Sale of Primary Residence
If your property values have increased significantly, your house may be worth more than the primary residence exclusion. For example, if you and your spouse bought a home eight years ago for $350,000 and sell it this year for $950,000, the first $500,000 of the gain would not be subject to capital gains tax with the married couple exclusion. But the remaining $100,000 gain could be. You may be able to avoid or reduce the capital gain tax by:
- Making sure you live in the house as your primary residence for two years.
- Seeing if you qualify for an exception, which may be allowed by the I.R.S. in certain circumstances if you sold the house because of work, your health or other unanticipated events.
- Keeping receipts for home improvements, including renovations, remodeling, landscaping, fences or new driveways.
Home Qualifies As Primary Residence
For a house to qualify as your primary residence before you sell it, you must live in it for two of the previous five years. But those two years do not need to be consecutive. For example, you may have lived there for one year when you first bought the house and then rented it for three years. To count as your primary residence, you would need to live there another year before selling it.
How To Avoid Capital Gains Tax On Sale Of Rental Property
There are several ways you can avoid paying capital gains tax on your rental property.
Convert Rental To Primary Residence
A common approach for homeowners who want to avoid paying capital gains on the property is to convert it from being a rental property into your primary residence. If it is feasible to do so before you sell, you could move into the house for two years for it to qualify as your primary residence.
1031 Exchange
You may avoid paying capital gains on the sale of the property with a 1031 exchange if you are using the real estate as an investment to generate income for yourself versus as your primary residence. With a 1031 exchange, you can defer capital gains taxes indefinitely if you keep reinvesting in other “like kind,” or similar, rental properties. There are specific rules and guidelines to follow to qualify for a 1031 exchange when buying and selling rental properties, including that your next investment property must be purchased within 180 days of selling the other one.
Be aware that if you sell property that was originally purchased as a 1031 exchange but do not reinvest the proceeds, you will have tax liabilities on that sale and any taxes that may have been owed through previous 1031 exchanges.
Opportunity Zones
Another way to reduce or avoid capital gains on property sales is to invest in real estate in qualified opportunity zones. Included as part of the Tax Cuts and Jobs Act of 2017, opportunity zones are certain areas that could benefit from economic growth in all 50 states of the U.S. The intent is to enable real estate investors to invest capital gains from property sales into an opportunity zone fund that will be used in specific neighborhoods and cities.
You can defer capital gains taxes until 2026 if you invest in an opportunity zone. If you hold the investment for 10 years or more, you will be exempt from owing any capital gains taxes on any future gains in the opportunity fund.
