As a homeowner, you’re faced with a variety of tax implications. If you’re considering selling, it’s important to understand capital gains tax on real estate transactions. With a clear picture of your potential tax liabilities, you’ll be prepared to make an informed decision on the timing of your home’s sale.
Find out more about capital gains tax and how it could affect your tax obligations.
The Capital Gains Tax, Explained
You incur capital gains tax when you sell a piece of property at a profit. Your tax rate will depend on a number of factors including the length of your investment, your income and your tax filing status.
The federal government and some state governments will collect capital gains tax on the sale of your home. Depending on your situation, you may pay a capital gains tax rate of 0%, 15% or 20%. Essentially all property that you sell will be subject to capital gains tax, not just your home. For example, you can pay capital gains tax on the profitable sale of a boat or vehicle or investments such as stocks.
It’s important to note that you’ll only be subject to capital gains tax on the profit made from the sale. You won’t need to worry about taxes if you break even or end up in the red. For example, let’s say you purchase a home for $100,000 and sell it for $150,000. At that point, only $50,000 of the sale would be subject to capital gains taxes.
Qualifications For Capital Gains Tax Exclusion
Although capital gains tax can take a bite out of your budget, there are many exclusions that you may qualify for.
The first major exclusion is that the IRS allows you to exclude $250,000 of capital gains tax if you’re single. If you’re married filing jointly, then the IRS will allow you to exclude up to $500,00 of capital gains on real estate.
With these generous exemptions, you may not need to worry about a tax bill that could be attached to your home’s sale. However, several factors could bar you from receiving this exemption. Let’s take a closer look at the possible things that could disqualify you from enjoying the capital gains tax exclusion.
If the home in question was not your primary residence, you may be disqualified from the capital gains tax exclusion. Just to be clear, the IRS defines your primary residence as the main home that you inhabit throughout the year. A second home or investment property won’t qualify for this exemption.
In order to prove that a property serves as your primary residence, you may need to provide documentation such as your tax return or voter registration card.
Length Of Ownership
If you have not owned the home for at least 2 years, then you may not be able to enjoy the capital gains tax exclusion. You’ll also need to live in the house for at least 2 years of the last 5 before you finalized the sale.
With that, you’ll have a finite window of time from the day you move out to qualify for the capital gains tax exclusion.
Investment And Tax History
As an investor, you won’t be able to take advantage of the capital gains tax exclusion. You won’t be able to claim the exclusion twice within a 2-year period. Additionally, if you obtained the property through a 1031 exchange in the past 5 years, then you won’t qualify for the exclusion.
A final disqualification reason is if you are subject to expatriate taxes. With that in play, you wouldn’t be able to claim the exemption.
If you’re worried that you won’t qualify for the exemption, consider whether you might qualify for an exception to the standard rule book. The IRS has some guidance in place to allow homeowners to exclude a portion of their capital gains if they were forced to move due to an unforeseen event, due to work or for health reasons.
The Capital Gains Tax Rate In 2020
As you move forward with your home sale, it’s important to consider the tax consequences.
The Short-Term Tax Rate
If you owned the property for less than a year, short-term capital gains taxes would be assessed. With a short-term tax rate, you’ll pay taxes based on your income tax bracket. In many cases, the short-term rate will be larger than the long-term capital gains tax rate.
As an example, let’s say that you bought a property for January for the purchase price of $100,000. After 6 months, you sold the property for $150,000. At that point, your tax liability would be based on the $50,000 profit. If you earned $50,000 from other income sources in the same tax year, then your total taxable income would be $100,000. With that, your marginal federal tax rate would be 24% and lead to over $11,000 in short-term capital gains taxes.
The Long-Term Rate
In general, the long-term capital gains tax rate is lower than the short-term tax rate. If you’ve owned the property for more than a year, then you’ll likely fall into the long-term capital gains tax category.
In many cases, you will qualify for a 0% tax rate. If you don’t qualify for that rate based on your income, then you’ll pay either a 15% or 20% rate.
Avoiding Capital Gains Tax On Your Home Sale
If you’d rather avoid a large tax bill, then there are some strategies to lower your capital gains tax liabilities. With careful planning and foresight, you could save yourself thousands of dollars.
Stay Put For At Least 2 Years
The generous tax exemption that we discussed is available for homeowners who lived in the property for at least 2 of the last 5 years. It is important to note that these 2 qualifying years can be nonconsecutive.
As an established primary residence, you may qualify for high dollar exemptions with your home sale.
Add Up Your Purchase And Sale Costs
When you purchase a home, you will soon realize that your financial investment in the property is far more than the purchase price. It is a good idea to keep a record of these extra expenses to include in the total cost of your property.
A few of the expenses that you may want to record include closing costs, title insurance, a real estate agent’s commission and more. You can include these costs as a part of your total investment in the property.
Refer To Receipts From Home Improvement Projects
Home improvement projects could create a sizeable stack of receipts throughout the years. The cost of these improvements may be deducted from the total profit of your home’s sale. However, not all home improvement projects are eligible deductions.
A few examples of eligible home improvement projects include adding new rooms, building a deck and replacing the roof. If you aren’t sure if your home improvement project qualifies, then find out more to determine what category your home improvement falls into.
When in doubt, save your receipts! You can always consult with a tax professional when the time comes to make decisions about your capital gains tax obligations.
Get The Most Value For Your Home
When you purchase a home, you are making a large investment. Even if you aren’t moving into your forever home, the real estate landscape offers many opportunities to buyers and sellers. As a homeowner, you have the opportunity to build equity in a property. If you choose to sell your primary residence, capital gain tax exclusions ensure that you are not unfairly penalized.
If you are unsure about your tax obligations upon the sale of your home, then take more time to learn about the subject. With a better understanding of your real estate investment, you can ensure that you maximize the rewards of your home’s sale.