Selling your home at a high price is great, but that feeling can quickly diminish once you realize you have to share your profit with the IRS. This is because capital gains on real estate can be taxable. This type of tax preparation requires particular attention to detailed and reliable tax compliance, which can be achieved with our accounting services.
With the help of professional tax experts at Waters Hardy, we can show you how to minimize or even avoid a tax hit on the sale of your house. Let’s take a closer look at how capital gains on real estate works and how you can avoid a big tax bill.
What is Capital Gains Tax?
A capital gains tax is the amount you owe from profits made after selling assets, like securities such as stocks and bonds and tangible assets like real estate, cars, and boats. The difference between what you pay for an asset and what it sells for is what the IRS and many states use to determine capital gains.
Capital Gains on Real Estate
Depending on your tax filing status and the sale price of your home, you may be eligible for an exclusion. The IRS typically allows you to exclude the following amount of capital gains tax:
- Up to $250,000 – filing single
- Up to $500,000 – married and filing jointly.
If the money you make by selling your home is taxable, your capital gains tax rate depends on your situation.
Short-term Capital Gains Tax Rates
Gains from assets you have owned for less than a year are taxed at a rate equal to your ordinary income tax rate, also known as your tax bracket.
Long-term Capital Gains Tax Rates
Gains from assets you have held for more than a year are considered long-term capital gains and are taxed depending on your taxable income. The higher your income, the higher the taxes you will pay on you gain.
Selling Your Primary Home
A primary home is where the owner has lived in for at least two out of the five years leading up to the sale will pay no capital gains tax for up to $250,000 for single ($500,000 for joint filers). Any gain above those exclusions is taxed at capital gains rates.
Selling a Primary Home Used for a Home Office Deduction
The tax implications are the same whether the home office deduction was previously claimed. In general, the $250,000 ($500,000 for joint filers) capital gains tax exclusion applies for the sale of a primary home.
Two exceptions include:
- Unrecaptured Section 1250 gain (more details below)
- If the workspace or rental space is in a building on the property that is separate from the main home.
Destruction of Your Primary Home Due to Wildfire, Hurricane, or Other Natural Disasters
Suppose a natural disaster or a federally declared emergency causes damage or destruction to your primary residence. In that case, your gain will be the total of the insurance proceeds after your pre-disaster tax basis on the property. If owned for at least two years, the gain is excluded from income up to $250,000 for single ($500,000 for joint) filers. Any gain in addition to that amount is subject to capital gains tax rates.
Short Sale of Your Primary Home
If a mortgage lender agrees to accept less than the remaining balance of your loan will affect the tax laws for short-term sales. However, tax rules for short-term sales differ depending on whether the debt is nonrecourse. When debtors remain personally liable for any shortfall, this is recourse debt. If the lender forgives the remaining debt, up to $750,000 in forgiven debt on a primary home is tax-free. The rest is taxed to the debtor at ordinary income tax rates up to 37%.
Nonrecourse debt means the debtor isn’t personally liable for the deficiency. The waived debt is included in the amount realized for calculating the capital gain or loss on the short sale. For primary homes, no loss is allowed and up to $250,000 of gain ($500,000 for joint filers) can be excluded from income for homeowners that owned the home for at least two of the last five years.
Selling a Rental Home
The gain or loss from selling a rental property is the amount realized on the sale and your tax basis on the property. If a rental property is held for more than a year, the long-term gain is taxed at the 0%,15%, or 20% rate, plus the 3.8% surtax for people with higher incomes. Otherwise, it is a short-term capital gain or loss.
Selling Rental Property Previously Claimed as a Depreciation Deduction
This is similar to the capital gain tax on a rental property, but a special rule is applied to the gain on the sale if you take depreciation deductions. Moreover, when the depreciable property is held for more than one year and sold at a gain, you may have to pay a capital gains tax of up to 25% on any unrecaptured depreciation. This taxable amount is known as an “unrecaptured Section 1250 gain.”
Selling a Vacation Home
A capital gain made on the sale of a vacation home does not qualify for the capital gains exclusion that applies to the sale of a primary home. It is subject to the standard capital gains tax rules. Additionally, upper-income individuals who owned the home for less than a year before selling will also pay an additional 3.8% surtax.
Selling a Converted Vacation Home
If you’ve converted a vacation home into your main home and have lived in it for at least two years, some or all the gain is ineligible for the home-sale exclusion. The amount of gain is taxed depends on whether the house was a second home or was rented out throughout the entire time the seller owned the property. After that, the remaining gain is eligible for the home-sale exclusion.
How to Avoid Capital Gains Tax on a Home Sale
Live in the house for at least two years.
- Selling a home in less than a year makes you subject to the short-term capital gains tax.
See whether you qualify for an exception.
- If you sold your home because of work, health, or “an unforeseeable event,” you may be able to exclude some of this tax.
Keep the receipts for your home improvements.
- Home improvements such as remodels, expansions, new windows, landscaping, fences, new driveways, and air conditioning installed throughout the years might cut your capital gains tax.
Making Capital Gains Tax on Real Estate Work for You
Calculating capital gains tax on real estate can be complicated and challenging. You need to factor in your taxable income, how long you held the property, and the type of property you sold. Professional accounting services, like our tax experts at Waters Hardy, are experienced in tax compliance relating to your capital gains real estate tax.
Learn more about how our complete tax preparation services can ensure you’re making the best move with your real estate capital gains taxes.