Many people get a massive payday after selling their homes. The monthly mortgage payments chipped away at debt, giving you more equity. However, any large transaction makes people wonder when taxes come into play. The taxes on your real estate sale will reduce your profits, but we’ll share some strategies to limit the damage.
Sellers have to pay several taxes on a home sale. We will discuss these taxes and ways to lower your bill.
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Capital Gains Tax
You will have to pay taxes on an investment that appreciates. Sellers can delay these taxes by holding onto the property for as long as possible, but you’ll have to pay them when you sell. This is because the IRS calculates your capital gain by taking the difference between the cost basis and the purchase price.
Your property’s cost basis is the amount you paid for the property. For example, if you bought the home for $500,000 (cost basis) and sell it for $700,000, your capital gain is $200,000. The amount you pay depends on your tax filing status, the home’s status, and the capital gain. Under current rules, you would not owe taxes on the $200,000 capital gain. The IRS single tax filers exclude up to $250,000 in capital gains for tax purposes. If you are married and file taxes jointly, the IRS lets you exclude up to $500,000 in capital gains for tax purposes.
If you are married, file taxes jointly, and generate a $700,000 capital gain, you will owe taxes on $200,000 of capital gains. These rules apply to your primary residence, but you’ll owe all of the capital gains for an investment property or second home.
Property Tax
The seller has to pay prorated property taxes when they hand off their home. If you lived in your home for three months before selling, you would owe 25% of the annual property tax. Sellers have to pay property taxes at closing. The amount you pay depends on the state. New Jersey has the highest property tax rate, while Hawaii has the lowest. It would help to look at local property tax rates to determine how much you will pay.
Real Estate Transfer Tax
The government taxes sellers on the transfer of ownership. The government takes a small percentage of your home’s purchase price for this tax. Rates vary in each state, but most people pay less than $1,000 on this tax. In a seller’s market, you might get the buyer to pay this tax for you during the closing. Buyers may do everything possible to secure the property, including pay off some of your closing costs.
How Much Do You Have to Pay on Taxes?
The amount you pay in taxes varies by each state and county, but you can calculate this number. Start with the final price of your home. The property and real estate transfer taxes come from a percentage of your home’s sale price. Find the percentages that apply to you and add the numbers together.
The final step is calculating capital gains. You’ll know how much qualifies for taxes after calculating the difference between the selling price and cost basis. Married couples filing together can exclude the first $500,000 in capital gains for taxing purposes. A single filer only gets to exclude $250,000. You can add any home improvements to your cost basis to minimize your taxes. For example, if a married couple bought a home for $500,000 and sold it for $1.1 million, they would normally owe $100,000 in capital gains taxes. However, if you put $200,000 into home improvements, you can raise your cost basis and avoid capital gains taxes.
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.
Additional Tax Rules for Home Sales
We’ve already covered some of the basics, but each transaction is complex. So keep these additional tax rules in mind when selling a home.
- Investment properties don’t receive the same tax treatment: The IRS won’t ignore the first $250,000-$500,000 in capital gains depending on your filing status. The IRS only makes this exception for a primary residence. You’ll owe capital gains taxes on the entire difference between the cost basis and the selling price.
- You haven’t lived in it long enough: Some real estate investors accumulate properties and bounce from house to house. You may live in a property one year and rent it out the following year. The government will look at how long you have lived on the property over the past five years. If you’ve lived in the property for under two years during that timeframe, it’s not considered a primary residence. You will have to pay taxes on all of the capital gains. Exceptions apply if you or disabled or served in the military, foreign service, or intelligence community—view IRS Publication 523 for details.
- You used up your capital gains break earlier: You don’t get to save $250,000-$500,000 on every transaction. You don’t qualify for it again if you’ve used this tax break within the past two years. Wait over two years before selling your new primary residence to get the capital gains tax advantage.
- You used a 1031 Exchange: A 1031 Exchange lets you defer capital gains taxes on your property. If you buy a similar property quickly enough, you can avoid capital gains taxes. You’ll owe more capital gains taxes on the next property sale, but you can continue deferring through 1031 Exchanges. If you give the property to your heir, the cost basis gets stepped up. For tax purposes, it’s as if the heir acquired the property on the date of death. Under this scenario, the previous capital gains are unaccounted for and never appear again. You can use 1031 Exchanges for a primary residence or investment property.
- Expatriate Taxes: If your property is overseas, you still owe capital gains taxes in the U.S. You must report capital gains and rental income from an overseas property on Form 1040. Put capital gains in Schedule D and rental income on Schedule E.
Can You Avoid Paying Taxes on a House Sale?
Everyone wants to avoid paying as much taxes as possible. It’s a natural reaction considering the different ways we get taxed in our lifetimes. We’ll share some strategies that can help you navigate taxes.
Qualifying For Home Sale Tax Breaks
The home sale tax break lets you evade taxes on some of your capital gains. You can qualify for a home sales tax break if you meet the following parameters:
- You have owned and lived in the property for at least two of the past five years
- You haven’t used the $250,000 or $500,000 tax break on real estate capital gains for the past two years
- One or both spouses can fulfill the ownership requirement
Qualifying For a Reduced Home Sale Exclusion
A reduced home sale exclusion lets you qualify for tax advantages even if you don’t fulfill the 2-out-of-5 criteria from earlier. You can qualify for this exclusion if you meet any of the following conditions:
- A change in employment
- A change in health
- An unpredictable event such as a divorce
How To Report Your Home Sale on Your Taxes
If your profits exceed the exception, you will have to report your home sale on your tax returns. Excess capital gains go in Schedule D of Form 1040. If you receive a Form 1099-S, you must report the sale even if you don’t owe taxes on the gains.
