While you'll be pleased if your real estate agent has helped you get a great price for your home, you could find you have more taxes to deal with. If your home has increased in value significantly, there could be real estate capital gains taxes to pay.
With the way real estate market values have exploded across the country over the last few years, it is certainly a possibility. Many homeowners are sitting on a significant amount of equity they didn't have just a few short years ago.
While on the one hand that is fantastic, taking money out of your pocket to pay taxes is never a good thing.
No one really likes paying taxes, so you'll be glad to know there are some ways to avoid the taxes selling a home can attract. It is vital to understand the capital gains tax on real estate when selling a house. The Maximum Real Estate Exposure article will give you a comprehensive overview of how capital gains taxes work.
What is Capital Gains Tax on Real Estate?
If you have made a profit when you sell your house or other assets, the IRS or state tax agencies will want their share. Capital gains tax can apply to any asset or investment you own, and if it has gone up in value, you could owe taxes.
Real Estate capital gains are just that - taxes on real estate profits.
How to Avoid Real Estate Capital Gains Taxes
Fortunately, the IRS gives you some ways to avoid paying capital gains. If you are single, you can exclude $250,000 from your gains when you sell your home. And if you're married, you can exclude $500,000.
This could cut your capital gains taxes when selling a home by a large amount or even completely. For example, if you purchased your home years ago for $250,000, and it's now worth $700,000, you might not owe anything to the IRS if you are married. But if you are single, you could find yourself paying taxes on $200,000.
When Does the Capital Gains Exclusion Not Apply?
There are quite a few situations when your $250,000 or $500,000 exclusion won't help reduce your tax bill:
- If the property wasn't your main residence, the exclusion doesn't apply.
- The exclusion will not apply when you haven't either lived in or owned the home for 2 of the previous 5 years.
- If you have already made use of the exclusion, you need to wait 2 years before claiming it again.
- If you gain the property through some kind of exchange, perhaps switching it with a different type of investment, you can't claim if it happened in the last 5 years.
- If you have to pay expatriate tax, you won't get an exclusion on capital gains.
If You Do Have to Pay Taxes Selling a Home, How Much?
If you don't qualify for an exclusion or cover all of your gains, you could pay two different possible tax rates.
The short-term capital gains rate will apply if you have owned the home for less than a year. The tax applied will be the same as your income tax rate.
If you have owned the home for longer than a year, the rate you will have to pay will be less. Some people will even qualify for 0%, with everyone else having to pay between 15% and 20% depending on your income and other factors.
It will be essential to speak with a qualified tax professional to determine exactly what you will pay for real estate capital gains taxes.
Steps You Can Take to Avoid Capital Gains Tax
To make sure you do as much as you can to avoid paying capital gains tax, there are some steps you can take.
Home Improvements
If you have made improvements to your home, you can use these expenses to reduce your tax bill. If you don’t have an exclusion, you can use receipts from improvements to increase your cost basis. The cost basis also includes the amount you paid for the home, and if you can push it higher, there will be fewer capital gains to pay.
Any improvements that you have made to the home since you moved in could be used. This could include renovations, additions, landscaping, kitchen appliance upgrades, and more. Keep in mind repairs to your home are not the same thing as improvements. You cannot use repairs to increase your basis and lower the taxes you'll pay.
Time in the House
To qualify for the exclusion, you need to have lived in the home for at least 2 out of the last 5 years. These don’t have to be consecutive, however, to qualify.
This could be more of a problem for house flippers and other investors. And if you've owned the house for under a year, there will be increased taxes when you sell.
Costs of Selling The Property
Remember that the costs of selling your home can also be used to bring down your tax bill. Don't forget about any seller concessions or real estate commissions you may have paid. These costs will bring down the basis for which you'll be taxed.
Using Exceptions
Even if you think you aren’t able to claim an exclusion, there could be an exception that helps you. For example, if you had to sell the home due to an unexpected event, because of a change of job, or for health reasons, you could get an exception.
This could allow you to reduce some or all of the increase in value of the home. The IRS Publication 523 provides more information on exceptions.
Final Thoughts
When you are selling a home, you will be asked to fill out tax documentation at the home closing. You will let the IRS know exactly how the sale of your house impacts their ability to collect taxes from you.
Understanding the real estate capital gains tax laws is essential as a homeowner. You can save yourself a substantial amount of money when you take the deductions you're entitled to. If you have any doubts about your tax standing, also speak with a qualified tax professional.
Hopefully, you have enjoyed these tips on avoiding capital gains when selling a house.
