There is a lot of confusion when it comes to capital gains on home sales. Part of this is because there are so many exclusions that some people believe that capital gains don’t even apply to home sales. Well, the truth is that they do apply, but there are a lot of conditions and potential exemptions surrounding them. To use the law to the fullest advantage, real estate sellers should have a better idea of what they’re up against.
The Progressive Scale
Capital gains refer to the amount of appreciation on an asset over time. In this case, assets can refer to anything from stocks to real estate. So if a buyer purchases a home for $150,000 and then sells it for $500,000, their capital gain would be $350,000 minus certain deductible expenses. These gains are taxed based on a seller’s yearly income (for simplicity’s sake, capital gains are added to the seller’s income.) For long-term capital gains, those making $37,950 and under are exempt from taxes. Those making between $37,951 and $418,400 pay 15%, and those making anything over $418,400 will pay 20%.
If a seller has made the home their primary residence for at least two years and sells the home within five years of the original date of purchase, they may be exempt from capital gains. Every owner of the home is allowed to exempt up to $250,000 worth of capital gains, whether the owners are married or not. The years of residence do not have to be consecutive, and the benefits can still be applied to rented homes so long as the criteria are still met. So if three friends are co-owners of a home, they can live in the home for the first six months, rent it for two years, and then move back in for 1.5 years before they sell. Professional home flippers should know that this benefit is not available to sellers more than once in two years.
Most home-related expenses are allowed to be deducted from the total net appreciation. This includes seller’s closing costs, real estate agent fees, and any potential renovations the seller did for the home. Sellers can even add on home sale costs from the original purchase of the home to close the gap even more. So if a buyer purchases a home for $100,000 and sells it for $200,000 10 years later, they’re able to limit the amount of taxes paid based on home renovation projects over ten years as well as real estate costs and fees.
If a seller is purchasing a new property that’s similar in price, they may also be able to forego capital gains. So for the buyer who buys at $100,000 and sells at $200,000 10 years later, they may be able to purchase another property for $200,000 without having to pay capital gains. This option will defer taxes as opposed to eliminating the need to pay them all together, but it may make purchasing a new property a little easier to bear. A 1031 exchange can be a complex transaction, so sellers are highly encouraged to talk to a tax professional for more information.
Capital gains for home sales may have a lot of conditions and exclusions, but they don’t necessarily have to be a disadvantage for home sellers everywhere. Whether the seller has owned the property for six months or 60 years, there are ways to work with the rules to achieve a successful home sale.