Capital Gains Tax and the Sale of Your Home
Homeowners interested in selling a primary residence may want to know more about the capital gains tax and applicable exclusions to avoid handing over a chunk of the profits to Uncle Sam. Whether a seller is able to qualify for a full or partial exclusion, either translates to less money given to the IRS.
Learn more about capital gains tax and full and partial exemptions on the sale of a home today.
What is Capital Gains Tax?
This is a tax on the profit from the sale of a home or other major asset. If a homeowner has owned their home for over one year, any profit would be a “long term” capital gains and the rate of taxation would depend on the seller's tax bracket. Significant exemptions exist for those selling a primary residence. However, those who own and are planning to sell a second home or vacation home may be able to use the exemption available for primary residences. It would be important to speak to a tax accountant to determine whether or not the sale of a second home could qualify and some planning would be necessary to take advantage of such an exemption.
The Basics of Capital Gains
Capital gains (or losses) only occur when selling a home. If the home price rises and falls during the time it's owned, it's called unrealized capital gains (or losses.) For most capital gains, the seller reports the net increase on the security on their income tax report. For those in the lower tax brackets (10 – 15 percent), capital gains are not taxed. For those in the highest tax brackets, capital gains are taxed at 20 percent.
The average percentage of long-term capital gains is 15 percent. Short-term gains refer to any securities held for one year or less, and they're taxed as normal income without a separate bracket. If the home is sold at the same price or at a loss, the homeowner pays no taxes.
Capital Gains for a Home Sale
A home sale in the US has several different provisions that may allow the homeowners to keep the full amount of their capital gains. If the homeowner has used their home as their primary residence for more than two years of the last five years, they're eligible for $250,000 worth of capital gains at a tax-free rate. Should the homeowner file a joint sale with their spouse, this number increases to $500,000. However, this may change for tax years 2018 & forward due to the possible new tax bill. Check with your tax advisor.
Any home and real estate agent fees, including closing costs, are deducted from the total capital gains. Should the homeowner make improvements on their land at any time while living in the home, they can increase the base value of the house from the time of purchase. However, if the homeowners filed tax-free capital gains in the two years prior to selling their home on another home sale, this rule generally does not apply. This way, it limits the number of home flippers who may use this exemption to skirt paying taxes.
Have You Heard of the $250,000/$500,000 Exemption?
Due to the Taxpayer Relief Act of 1997, an exemption is allowed to individuals and couples on the sale of a primary residence. Singles may receive an exemption of $250,000 in capital gains. Couples may get up to $500,000. No federal income tax is levied on the profit of a principal residence up to $250,000 and $500,000 respectively. In addition to the sale of a house, other residences that can qualify for the exemption include condominiums, apartments, fixed mobile homes and stock-cooperatives.
The law can be applied on any number of sales of a primary residence. Homeowners must have lived in the home for a minimum of 2 out of 5 years prior to a sale. This does not apply to any properties that are considered to be investment or rental properties. Medical exemptions and unforeseen circumstances can allow an owner to get around the 2 out of 5 year rule. Those that may not qualify for a full exemption may be able to get a partial exclusion. This is certainly something to consider whether selling a home in Hutto TX or elsewhere.
What is a Partial Exemption?
Some sellers may not be able to get a partial exemption on the sale of a home. Documentation of the following circumstances would be necessary. Homeowners may qualify for a partial exemption if:
- A new job or job change required the sale of a house;
- Health issues necessitated the move; or
- Natural disasters or unforeseen circumstances forced a homeowner to move.
This exclusions only apply to any profit from the sale of a primary residence. Homeowners who sell at a loss do not get to benefit from these exclusions. Additional profit on the sale of a primary residence over the maximum limit of $250,000 and $500,000 would still be subject to capital gain taxation.
A seller who has sold a primary residence needs to declare any profit on Schedule D. The amount is reported as a capital gain and a short-term capital gain and long-term capital gain are reported differently. A short-term capital gain is reported on a home owned for a year or less. Speak to a tax accountant directly for additional details.
The rules for paying capital gains tax changed in the late 1990s. Prior to the adjustment in restrictions, homeowners would have needed to put 100 percent of their profits into a new home sale if they wanted to avoid paying capital gains taxes. If a Spicewood homeowner is planning to reinvest all of their profits into another investment property today, they may qualify for a 1031 exchange where capital gains tax is excluded.
It should be noted that 1031 exchanges can be complicated, so a tax professional may be needed to successfully complete one. In addition, opting for the capital gains tax exclusion doesn't prevent the homeowner from ever using the property as a rental. The restrictions do not state the homeowner has to have used the property as their primary residence for consecutive years. So if a homeowner lives in the home for one year, rents it for one year, and then lives in it for another year, they would still qualify for the exemption.
Paying Capital Gains Taxes on a Home Sale
Sellers are obligated to pay capital gains taxes when appropriate. However, some may be unaware of the exemptions that may apply. Learn more about requirements and any changes before the sale of a home.