If you have ever sold a home, you know that there are taxes that need to be paid. One of the potential taxes that you might be paying is the capital gains tax. This tax is levied on the increase in the value of your home over the course of your ownership.
For most people their home is one of the most significant assets they will own in their lifetime. Some folks have put many hours of blood, sweat, tears into their homes.
Once it comes time to sell most want to maximize their returns as much as possible. Not only do they want to sell high but they also want to have their tax bill minimize is best it can. Avoiding a real estate capital gains tax if possible is usually a common goal.
But how is it possible to do that? Let's take a look at how real estate capital gains taxes work and if you can avoid having a bill.
What Are Capital Gains Taxes?
When you sell a home, Uncle Sam will be looking for their fair share on any profits you have made from the sale. The Federal Government and also many states will assess a capital gains tax on the difference for the purchase price of your home vs. what you end up selling it for.
The purchase price of the house becomes your cost basis. The cost basis usually includes the purchase price combined with improvements you have made during the time of ownership and the costs of selling such as paying a Realtor's commission.
There could be other home selling costs you can also claim to bring down your tax basis.
When you cost basis increases, it is possible your capital gains will decrease. Think about things you may have done like installing a new heating system, replacing the roof, adding new windows, or putting on an addition.
Keep in mind that repairs do not count as improvements.
How Does Capital Gains Taxes Work When Selling a House?
One of the terrific benefits you get with owning a home vs. renting is the real estate capital gains tax exclusion. It is very possible you could selling your home and not have to pay any capital gains taxes.
The way the capital gains tax exclusion works is if you are married and filing jointly, you can exclude $500,000 in profit from having to pay taxes on it.
If you are single, you will get an exclusion of $250,000 in profit from paying capital gains.
For example, if you purchased a home many years ago for $300,000 and sold it today for $700,000, you would pay no taxes on the sale if you're married and file together.
If you are single under the same circumstances, you would only pay capital gains taxes on $150,000 of profit. $400,000 in profit less the $250,000 exclusion equals $150,000 that is taxable.
When Do You Pay Capital Gains Taxes From a House Sale?
There are circumstances when you will pay capital gains taxes on the whole gain on your home sale. This will happen when the house was NOT your principle residence or if you owned the house for less than two years.
You will pay capital gains taxes if you didn't live in the house for at least two out of the five years before you sold it. There are some exceptions to this including those who are in the military of in the intelligence community. Speak to a qualified tax professional to see if you are eligible.
You will also not be able to claim a deduction if you have already claimed one on another home in the last two years before selling this one.
If you are subject to the expatriate tax you will also not be able to claim the deduction.
How to Figure Out Your Capital Gains Tax Rate
When you have additional profit on the sale after any capital gains tax exclusions are applied, you will need to figure out your taxable rate.
The first thing you need to figure out is whether your gain was short or long term. There are different tax rates for short and long term capital gains.
Generally speaking short term capital gains usually apply when you own for less than a year. Your profit will be taxed at your ordinary income tax rate based on the tax bracket you fall into.
Long term capital gains usually apply when you have owned for longer than one year. What your tax rate will be figured on depends on your filing status and your yearly income.
The resource above at Maximum Real Estate Exposure goes into great detail covering the tax brackets and the income range for each. Look at this as a guide for the percentage of capital gains you will pay.
The Best Way to Avoid Paying Real Estate Capital Gains
The easiest way to avoid paying capital gains is to live in your home for at least two out of the last five years. Selling before then will end up in a higher tax bill. The two years do not need to be back to back.
Everybody's taxes are different. Whenever you are trying to figure out what taxes you will owe the Internal Revenue Service, it is always best to speak with a qualified tax professional.
There are many advantages for owning a home and the real estate capital gains tax exclusion is one of them.