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Capital gains tax is levied on the profit from the sale of a house. This sale counts towards your total capital gain for the year and is taxed at the normal rates of 0%, 15% or 20%.
That said, when it comes to home sales, the IRS allows you to exempt some of the profits from your taxes. If you sell your primary home, you can exempt up to $250,000/$500,000 (single/married) from your taxes over your lifetime.
For example, suppose you sell your house for a profit of $435,000. As an individual, you will likely owe taxes on $185,000 of these winnings if you have not previously used this exemption. Here’s what you need to know. You can also match with a financial advisor who can help you apply the rules to your own situation.
When you sell real estate, any profits you make are taxed as capital gains.
Profit in this case is defined as your sales price less the property’s tax basis. The tax basis of a property is based on several factors, but generally it is the total amount you spent to buy, upgrade and sell the property. This may include, but is not limited to:
Original retail price
Additions, changes and updates
Staging, fees and related costs of the sale
Depreciation or loss of value
Crucially, this excludes maintenance and upkeep. For example, replacing your washing machine as soon as it stops working properly does not count as an upgrade. Your cost basis increases with money that adds to the overall value of the property, such as a bathroom renovation or adding a room. This is called “qualified expenses.” So for each property, your profit (or ‘taxable profit’) is calculated as follows:
For example, suppose you spend $450,000 to buy a house. You then spend $15,000 on modernizing and expanding the kitchen. Right now, your cost basis for the house is $465,000. If you sell the house for $500,000, your profit will be $35,000 ($500,000 – $465,000).
Any profits from the sale of real estate, including a home, are taxed as capital gains. This means they will be subject to a lower tax rate, separate from income tax, although your capital gains rate is determined by your total taxable income. For most households, the capital gains rates are:
0%: up to $47,025 single / up to $94,050 joint
15%: $47,025 – $518,900 single / $94,050 – $583,750 joint
20%: $518,900+ single / $583,750+ joint
So in our example above, you might have $35,000 in profit from the sale of your house. As an individual or married couple, you fall within the 0% tax bracket, assuming you have no other income. This is different than if you earned $35,000 from a job, in which case you would be within the 15% capital gains tax bracket.
Consider talking to a financial advisor about capital gains tax strategies and more.
When you sell your home, the IRS offers you a limited lifetime exemption from applicable capital gains taxes. An exemption is an amount of money you deduct from your profits or income before calculating your taxes. This, in turn, lowers your overall taxes by reducing the money subject to tax. This exclusion is known as the Home Sale Exemption or a Section 121 Exclusion.
The home sales exemption applies if you sell your main home. This allows you to exempt up to $250,000 for individuals or up to $500,000 for married couples filing jointly. This exemption applies to the gain of the sale of your house, not of the price. This exemption is non-refundable, meaning you cannot reduce your tax burden below $0.
In our example above, let’s say you sell your house and receive $35,000 in profit after expenses. You would then exempt the first $250,000/$500,000 of that profit and only report the rest to your taxes. This would reduce your taxable gain to $0. And the next time you sell a home, you may be able to exempt yourself from a residual gain of up to $215,000 as a single filer.
There are a number of requirements that a sale must meet in order to meet the home sale exemption. Collectively, these requirements are known as the “ownership and use test.” They are:
The home must be your main residence
This must have been your main residence for at least 2 of the past 5 years
You must own the property
The main residence rule means that you cannot apply this exemption, for example, when selling a rental home, second home, holiday home or similar home. You can only have one main residence at a time, but the period of residence cannot be consecutive. This means that the house could have been your main residence for 12 months, then you can move and then you can have it as your main residence again for 12 months.
The purpose of the ownership and use test is to ensure that you do not forfeit a property, and to prevent individuals from claiming short-term stays in a holiday home in order to claim the exemption.
The Section 121 Exclusion completely replaced similar exchanges for home sales. You can’t take a similar exchange if you’re selling your home or other real estate for personal use, and that hasn’t been possible since the late 1990s. If you have questions about this rule, you can match with a financial advisor.
Do you pay capital gains tax here?
Suppose you are someone who just sold their house for a net profit of $435,000. This means that after taking into account the cost basis (purchase price and qualified expenses), you are still left with $435,000. Do you pay capital gains tax?
The answer is yes in almost all cases.
Assuming this is your main residence and meets the use and occupancy tests, you as an individual will receive an exemption on this sale worth €250,000. This reduces your taxable gain to $185,000. If you have no other taxable capital gains this year, you’ll move into the 15% tax bracket and generate capital gains taxes of about $20,696.
You cannot defer this tax bill by purchasing a new home or placing it in a like-for-like exchange. Both approaches are allowed for investment and commercial properties, but do not apply to residential properties. Taxes can be complicated depending on your personal circumstances. Consider speaking to a financial advisor who can help you create an appropriate strategy.
When you sell real estate, any profits are subject to capital gains tax. However, if you sell your primary residence, you can benefit from a tax exemption up to the first claim that will offset between €250,000 and €500,000 of your profit.
Selling your home is hopefully the largest financial transaction you will ever make. The second runner-up is when you purchased the home. So here are five quick and easy ways to ensure the transaction is as big as possible.
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