Avoiding Capital Gains Taxes on Home Sales

by | Nov 22, 2019

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When looking at selling your home, it can be exciting to think about the prospects of those sales figures coming in. However, before you think about what to do with that money, you have to take into account the effect capital gains tax will have on that sales income. As real estate experts, we’ll walk you through the basics of the capital gains tax, the exceptions where it doesn’t apply, and some things you can do to limit the tax that you owe.

What Is Capital Gains Tax

Capital gains tax is a tax assessed by the IRS that applies to the capital gain you get from selling an asset. That means it’s a tax on the difference between what you pay for an asset and what you sell it for. The tax applies to any number of investments, from stocks and bonds, to physical assets like cars and real estate.

How Does Capital Gains Work On Real Estate

For many people, their home is their largest asset. That means that the capital gains tax on the sale (15% in 2019) takes a big bite out of their assets. Thankfully, there are a few exceptions that are protected from capital gains tax. 

The IRS allows you to exclude a certain amount of capital gains from being subject to tax depending on your marital status. If you’re single, the first $250,000 of capital gains can be excluded from capital gains tax. If you’re married and file taxes jointly, the first $500,000 of capital gains can be excluded from tax.

Unfortunately, your lose your ability to exclude gains from tax if any of the following is true:

  • The property isn’t your primary residence
  • You didn’t live in the house for at least 2 years within 5 years of the sale (there are exceptions for those with disabilities and people in the military or overseas government service)
  • You claimed the exemption on another property within 2 years of the sale of this home
  • You owe expatriot tax

How To Avoid Capital Gains Tax

Even if you think you’ll be subject to capital gains tax, there are some steps you can take to limit what you’ll owe. First, given what we’ve seen about claiming exclusions, you can try to delay selling until you’ve lived in the home for at least 2 years. Keep in mind that these years down need to be consecutive, but must add up to 2 years within the 5 year period before the sale. Even if you aren’t worried about the standard capital gains tax, waiting could still be beneficial because if you sell a property within a year a short-term capital gains tax could apply to the sale as well.

Another step you can take is to see whether you may qualify for an exception. Even if the gains on the sale are subject to capital gains tax, you may still be able to exclude some of those gains of you had to sell the property because of your health, work, or an unforeseeable event. 

One last thing you can do is keep a record of all of the home improvements you’ve done on the property. This is because you can include the cost of these renovations as part of your cost basis, making your capital gain smaller so you owe less in taxes. 

While the capital gains tax can be frustrating, we’ve seen that it only applies to certain situations. If you’re selling the home that you live in it likely won’t apply, and even if it does there are steps you can take to limit your tax exposure.

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