Home Selling and Real Estate Capital Gains Taxes
Do you know how real estate capital gains taxes work when selling a house? Selling your home can net you a significant return. But what does the tax man have to say about it?
With property values across the country skyrocketing, now more than ever, it is important to understand capital gains taxes on the sale of a home.
Taxes on capital gains can get you big-time in certain situations, so it is crucial to understand how capital gains apply to your home sale before trying to rake in the money.
The rules have changed over the years when it comes to the capital gains tax on real estate, so it is crucial to know how they work now.
Luckily, it is easier for you to sell your home and realize a profit due to the capital gains tax exclusion. Making money tax-free is good news for anyone wanting to sell a home right now.
Understanding how capital gains work when selling a home is a key element to reducing your tax bill. You need to know the laws whether the home is your primary residence or a rental property.
By the time you’re done reading, you’ll have a much better handle on understanding the real estate capital gains tax.
Let’s take a deep dive into everything you need to know.
What Are Capital Gains Taxes?
A capital gains tax is specifically a tax on the money you have made from an investment. When a capital asset such as a house or other real estate is sold, your gains become realized. At the point of sale, it becomes taxable income.
The profits on the sale of your home never become taxable until a sale takes place. The capital gains tax applies to profits on assets held for longer than a year. These are referred to as long-term capital gains. The long-term capital gains tax rates are 0%, 15%, or 20%, depending on the tax bracket you fall into. As you can see, there is a wide difference from low to high for long-term capital gains rate.
A short-term capital gain pertains to assets that are held for less than a year. They are taxed as ordinary income. You will pay ordinary income tax rates depending on your tax bracket. For the vast majority, long-term gains are less costly than short-term gains.
Taxable capital gains for the year are reduced by the total capital losses incurred in that year. Capital losses are when you sell an asset for less than the sales price. Your long-term capital gains less any capital losses are known as the net capital gain. This is the amount on which capital gains taxes will be assessed.
That being said, real estate transactions are treated differently. You are allowed a substantial deduction whether you are a single person or are married. We will discuss this at length.
How Does The Capital Gains Tax Rate Work?
The following are the long-term capital gains tax rates for 2022:
Filing Status For Real Estate Capital Gains Tax
- Single: 0% up to $41,675
- Single: 15% between $41,676 – $459,750
- Single: 20% Over $459,750
- Married filing jointly: 0% up to $83,350
- Married filing jointly: 15% between $83,351 – $517,200
- Married filing jointly: 20% over $517,200
- Married filing separately: 0% up to $41,675
- Married filing separately: 15% between $41,676 – $258,600
- Married filing separately: 20% 0ver over $258,600
- Head of household: 0% up to $55,800
- Head of household: 15% between $55,801 – $488,500
- Head of household: 20% over $488,500
According to the Internal Revenue Service chart, in 2022, single people won’t have any capital gains taxes if their taxable income comes in at $41,675 or less.
The rate increases to 15 percent on capital gains for single filers if their income falls between $41,676 to $459,750. When your income increases above that level, the tax rate increases to 20 percent.
Your tax filing status can really make a difference when it comes to capital gains tax liability. The income tax you pay can vary substantially. As you can see from the IRS publication, there are tax benefits for being married and filing jointly for capital gains.
Single taxpayers often pay quite a bit more in taxes.
The following are the long-term capital gains tax rates for 2023:
Filing Status For Real Estate Capital Gains Tax
- Single: 0% up to $44,625
- Single: 15% between $44,625 – $492,300
- Single: 20% Over $492,300
- Married filing jointly: 0% up to $89,250
- Married filing jointly: 15% between $89,250 – $553,850
- Married filing jointly: 20% over $553,850
- Married filing separately: 0% up to $44,625
- Married filing separately: 15% between $44,625 – $276,900
- Married filing separately: 20% 0ver over $276,900
- Head of household: 0% up to $59,750
- Head of household: 15% between $59,750 – $523,050
- Head of household: 20% over $523,050
Short-Term Capital Gains Tax Rates For Tax Year 2022
When paying short-term capital gains taxes, the tax bracket for ordinary income will apply. For 2022 the tax brackets are:
- 10 percent for single filers up to $10,275, up to 20,55o for married filing jointly, and up to $14,650 for the head of household.
- 12 percent for single filers between $10,275 – $41,775, $20,550 – $83,550 for married filing jointly, $14,650 – $55,900 for head of household.
- 22 percent for single filers between $41,775 – $89,075, $83,550 – $178,150 for married filing jointly, $55,900 – $89,050 for head of household.
- 24 percent for single filers between $89,075 – $170,050, $178,150 – $340,100 for married filing jointly, $89,050 – $170,050 for head of household.
- 32 percent for single filers between $170,050 – $215,950, $340,100 – $431,900 for married filing jointly, $170,050 – $215,950 for head of household.
- 35 percent for single filers between $215,950– $539,900, $431,900 – $647,850 for married filing jointly, $215,950– $539,900 for head of household.
- 37 percent for single filers above $539,900, above $647,850 for married filing jointly, and above $539,900 for the head of household.
Short-Term Capital Gains Tax Rates For Tax Year 2023
When paying short-term capital gains taxes, the tax bracket for ordinary income will apply. For 2023 the tax brackets are:
- 10 percent for single filers up to $11,000, up to 22,000 for married filing jointly, and up to $15,700 for the head of household.
- 12 percent for single filers between $11,101 – $44,725, $22,001 – $89,450 for married filing jointly, $15,701 – $59,850 for head of household.
- 22 percent for single filers between $44,726 –$95,375, $89,451, – $190,750 for married filing jointly, $59,851 – $95,350 for head of household.
- 24 percent for single filers between $95,376 – $182100, $190,751 – $364,200 for married filing jointly, $95,351 – $182,100 for head of household.
- 32 percent for single filers between $182,101 – $231,250, $364,201 – $462,500 for married filing jointly, $182,101 – $231,250 for head of household.
- 35 percent for single filers between $231,251– $578,125, $462,501 – $693,750 for married filing jointly, $231,251– $578,100 for head of household.
- 37 percent for single filers above $578126, above $693,251 for married filing jointly, and above $578,101 for the head of household.
It is important to note that the income amounts that pertain to each tax bracket will differ depending on your filing status. For example, single filers will have a different tax liability and, therefore, different income tax than a married couple. A married couple could file a joint return or file separately. A tax return will differ, as will the amount of taxes you pay based on how you file.
Nerd Wallet has an excellent resource that breaks down all income levels for each tax filing status. Take a look to see where you fall to calculate the amount of capital gains you’ll pay.
As you can see, property owners really get whacked hard if they have to sell quickly. Sometimes there are unforeseen circumstances such as job changes that force a quick sale of your main home. Otherwise, it makes sense to stick it out to meet the residency requirement to have a long-term capital gains exclusion.
Real Estate investors who fix and flip properties are up against the short-term capital gains tax all the time. Creative ways to reduce their taxable gain are often needed. Short-term capital gains are treated just like regular income. That being said, let’s take a deeper look into the real estate capital gains tax exclusion.
Real Estate Capital Gains Rules Changed After 1997
If you sold a home pre-1997, you might be surprised to hear about the generous tax break you can get on your home sale. This is because the current real estate capital gains tax laws went into effect on May 7, 1997.
This tax code is referred to as The Tax Payer Relief Act of 1997. Before this time, you had to take the profit from your home sale and use it to buy another, more expensive house within two years. If you didn’t do this, taxation on your profits was inevitable.
The only other option you had to protect your earnings was based on age. If you were 55 or over, you could take an individual exemption one time in your life of up to $125,000. Either way, you had to fill out a particular form to prove to the IRS that you followed the rules.
The current laws went into effect with the Taxpayer Relief Act of 1997. This act made it much easier to sell your residence and enjoy the profit from the sale.
You can still use the money to buy a new home. But you can also use it to purchase a boat, car, or vacation. It’s up to you.
When you sell a home, it is essential to understand how lax tax laws work, just like when you purchase the property; you should know the home buying tax deductions. Understanding tax laws can save you thousands of dollars every year if you know what to look for.
Real Estate Capital Gains Tax Explained
Fortunately, real estate capital gains are one of the best tax breaks available to the average person. This means that you have little to worry about in most situations unless your home will bring in a significant amount of money.
You have to realize substantial gains on your personal home before you pay a penny to taxes. In most instances, the rules are as follows:
- If you are single, you can make up to $250,000 in profits from your home sale before you have to pay taxes.
- If you are married, you can make up to $500,000 in profits before paying capital gains tax.
Here is an example of the real estate capital gains law: Let’s say you were fortunate to purchase your home for $500,000, and it is now worth $800,000. Your $300,000 in profit or gain will not be taxed if you are married, as the $500,000 in profit is excluded from taxation.
So what happens if you are going to make more than $500,000 in profit? Under the current tax laws, you would be taxed at a 20% capital gains tax rate on the amount over the $500,000 threshold.
This is pretty exciting news for most home sellers. Granted, some areas have seen severe real estate booms, where you may be able to go over these numbers when you sell. But for most home sellers, there is little worry of needing to pay Uncle Sam for their home sale.
However, you do have to meet all of the requirements. Let’s explore those conditions so you can see how they apply to you:
Requirements For Taking Real Estate Capital Gains Tax Deduction
To qualify for the real estate capital gains tax exclusion, the following conditions must apply.
Must Be Your Principle Residence
You must pass the ownership test to qualify for the capital gains tax exclusion. There are special rules that apply in order to take advantage of this tax break.
The tax break is designed for people selling the home they live in or primary residence, not investment property. Rental properties do not apply for tax benefits. You have to live in this residence for two out of the last five years. Practically speaking, two years is not a long time to make a home your home. And the best part of this requirement is that it applies repeatedly.
You can live in a home for two years and sell it with no penalty. You can then buy another house, live there for two years, and sell again. There are no limits on how many times you can do this as long as you meet the two-year requirement.
You Need to Live in The Home For Two Out of Five Years
As far as living in the home for two out of the last five years, there are no hard and fast rules regarding this situation. You could have lived in the house the 1st year, rented it the next three, and lived in it again in the last year, and you would be okay as far as the capital gains exclusion goes. There are no rules in place for needing to live in the house for consecutive years.
Years ago, when the real estate market was a whole lot different, I had a friend who lived in Southborough, Massachusetts that would make a habit of residing in a home for a couple of years and then selling.
Tax Benefits Don’t Apply to Your Vacation or 2nd Home.
Keep in mind that selling your vacation home or second home does not yield the same tax benefits. Even if you move into the second home and live there for two years, some of the profit from the sale will still be taxable, based on how long the residence was used as a secondary home.
This tax rule would apply even if you were selling to a family member. You will also need to take into account your rental income generated.
Getting Married Can Bring Down Your Capital Gains Tax Bill
The doubled tax exclusion amount – $500,000 for married couples – is exceptionally appealing for some couples that have yet to get married. The tax laws are pretty forgiving here.
If you get married only a short time before the sale, you can still qualify for the higher break if both of you have been living in the home for two years.
So if you were living together for a year and a half, then get married and sell six months later, you should be able to qualify for the $500,000 tax break.
Understand Your New Spouse’s Home Sale History
Although the law is fairly lenient on residency times for marriages, it is not so lenient on previous exclusion uses. Previous marriages are a vital consideration when it comes to real estate capital gains taxes.
If your new spouse used the home sale exclusion within the past two years – like selling their house to move in with you – this would impact your ability to use it for the current home sale.
If they just sold the house, you will need to wait a full two years before you can take advantage of the complete exclusion. You may be able to get a partial exclusion, though, depending on your situation.
It would be advisable to consult with a qualified tax attorney on something such as this.
Wealthy Real Estate Tax Loophole Closed
In 2009, a law was put into effect that closed a tax loophole in the capital gains tax law. The code is known as the 2008 Housing and Economic Recovery Act. The law was put into effect as a means of preventing wealthy homeowners from avoiding paying taxes.
Before the loophole being closed, wealthy owners who own two or more homes could jump from one house to another to avoid paying capital gains.
These wealthy homeowners would avoid paying the capital gains tax by selling their primary home, claiming a full tax exclusion, and then moving to a second or third home that they have owned for some time. They would then make it their primary residence and then turn around and sell the home paying little or no capital gains tax.
The law’s modification says that the gain may not be excluded for periods of “non-qualified use,” mostly when the home was not used as the taxpayer’s primary residence.
Special Provisions for Extenuating Circumstances
The Military Tax Exclusion
The military tax exclusion – Being in the military has its benefits for capital gains taxes and selling a home. Because of being deployed, those in the military often find it hard to meet the residency rules and pay taxes when they sell.
A law put in place in 2003 exempts military personnel from the two-year use requirement mentioned above for up to 10 years, letting a serviceman or woman qualify for the full exclusion whenever they must move to fulfill their service commitments.
If you or your spouse is on qualified official extended duty, you’ll be eligible to extend the qualifying period.
There are also additional tax benefits for being a veteran that should be understood. Here is an outstanding reference on property tax exemptions by the state for veterans. If you qualify for one of the exemptions, it means less money is coming out of your pocket!
Your Spouse Passes Away
The death of your spouse – Another provision in the real estate capital gains tax law was changed in 2008. This change considers the unique circumstance an owner faces when a home sells after their spouse dies.
Previously to exclude the full profit amount excluded from taxes, the surviving spouse had to sell within the same year of the death.
The change allowed the widower to have up to two years to sell the property without facing the burden of paying taxes.
As long as the surviving spouse sells within the two-year window, they will be able to exclude the full amount of profit.
Understanding How Much is Capital Gains Tax
Another vital point to understand about real estate capital gains taxes is your exclusions. The way you figure out how much you can exclude is not just a matter of your original purchase price.
It would be best to determine exactly how much profit you made, minus what you put into the home. The investment you made into the home will be considered what you can deduct from your profit.
Profit is what is taxed, and gain is considered how much you made after your basis in the home is considered. The equation is not that complicated, but it does involve more than just the final selling price of your home.
To determine your cost basis in the house, you need to look at what you paid for the home, plus any capital improvements you made to the residence. Capital improvements can be the en suite bathroom renovation, the garage you converted into a recreation room, etc. These items will contribute to your adjusted basis bringing your capital gain tax down. You can think of them like you would a deduction.
By keeping detailed records, you can reduce your tax burden.
Know The Difference Between Repairs vs. Home Improvements
One thing to note is the importance of distinguishing between an improvement and a repair for tax purposes. Home improvements are allowed to count toward your tax basis; repairs are not. Understanding the difference between the two is paramount.
According to the internal revenue service, an improvement increases the value of your home, while a non-eligible repair returns something to its original condition. The IRS says that a capital improvement has to last for more than one year, add value to your home or prolong its life.
The perfect example to distinguish between the two would be fixing a window pain vs. installing replacement windows.
This is why it’s always a good idea to keep receipts for any improvements you make to your house. It all matters when you are calculating your basis. Once you know what you have invested, you can subtract that number from the home’s sale price to get your actual profit.
Remember that even if you do not meet the exact standards for the exclusion – say you lived there only a year and a half – you can still use a portion of it to protect your profits. The exact amount will be based on how closely you do fit the standards. You would be at 75% of the requirement at a year and a half, meaning you could get a 75% exclusion.
Speak to Professionals Before Selling Your Home
If you consider selling your house, talk to your Realtor and your accountant to precisely determine how the real estate capital gain laws apply to you. If you are like most people, you can sell your home without worrying about taxes. The IRS also puts out an excellent real estate tax guide to help answer questions you may have regarding taxes.
The information contained in this article is believed to be accurate. However, every person’s tax situation may differ; therefore, before acting on the information contained herein, you should consult a qualified tax accountant or attorney.
The Real Estate Capital Gains Tax Rules Differ For Investment Property
The way real estate capital gains taxes are dealt with on investment property is different. You will pay a twenty-five percent real estate capital gains tax rate for investments that are depreciated over time. The IRS would like to recapture some of the tax benefits you’ve been afforded via depreciation deductions over the years of ownership.
These investment assets are known as Section 1250 property. The collection is referred to as the depreciation recapture tax.
The IRS rule on investment property prevents you from getting a double tax break on the same property.
How Do Real Estate Capital Gains on Home Sales Get Reported?
You might be wondering how the IRS even knows what you will owe when selling a home. When you are at a home closing with your real estate agent, the bank attorney or closing agent will ask you to sign a tax document called the form 1099-s. This IRS form is your declaration to the IRS whether your home sale is a taxable event or not.
The document ensures that you accurately your profits, so the Internal Revenue Service knows whether you’re on the hook for a real estate capital gains tax. It’s hard to avoid paying capital gains on real estate unless you’re willing to lie. Doing so would not be wise.
Understanding the capital gains tax on real estate is paramount. Otherwise, you could end up costing yourself a lot of money when selling a house. Your real estate capital gains tax can vary based on a number of factors.
Nobody should pay more income taxes than they have to. If you have any questions on the tax laws as they apply to real estate, take the time to speak with a qualified accountant or tax specialist. You’ll be glad you did.
Hopefully, you now have a better understanding of how real estate capital gains taxes work.
Other Helpful Real Estate Tax-Related Articles
Use these additional resources to understand how the real estate capital gains and other tax laws work.
About the author: The above Real Estate information on real estate capital gains taxes when selling your home was provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at firstname.lastname@example.org or by phone at 508-625-0191. Bill has helped people move in and out of many Metrowest towns for the last 35+ Years.
I service Real Estate Sales in the following Metrowest MA towns: Ashland, Bellingham, Douglas, Framingham, Franklin, Grafton, Holliston, Hopkinton, Hopedale, Medway, Mendon, Milford, Millbury, Millville, Natick, Northborough, Northbridge, Shrewsbury, Southborough, Sutton, Wayland, Westborough, Whitinsville, Worcester, Upton, and Uxbridge MA.