Tax season can be stressful for anyone — but especially if you are a real estate investor or have recently sold a home. Your home is considered a capital asset, which means that it is subject to capital gains tax. If your home appreciated in value between the time you bought and sold it, you could be required to pay capital gains taxes on any profit you made.
Thanks to the Taxpayer Relief Act of 1997, however, most homeowners are exempt from capital gains tax — at least to a degree. If you are unmarried, you are eligible to pay no capital gains tax on the first $250,000 profit on the sale of your home (using the excess over cost calculation basis). Married couples, on the other hand, are eligible for a $500,000 exemption. Of course, there are some restrictions and things to keep in mind.
Capital Gains Tax on Real Estate
In order to be exempt from the capital gains tax, the home in question must be considered a primary residence, in accordance with the Internal Revenue Service (IRS) rules. Based on these rules, you must have been living in the residence for two or more years over the past five years.
In other words, if you bought your home and then sold it one year later because the market was hot, you would be responsible for paying capital gains tax on the profit from your sale. And, even if you have lived in your home for the past two years, you may still owe taxes on the profit if your profit exceeds the IRS thresholds mentioned above.
You can even use this rule to avoid capital gains tax on a rental property, since the residency requirement doesn’t need to be fulfilled consecutively. Let’s look at an example. Say you purchased a condo four years ago for $400,000, in a buyer’s market. You lived in the condo for a year, and then moved out when you got married and converted the condo to a rental property for the next three years. Once your tenants move out, you move back in for the next year and then get ready to sell because the market is hot. Thanks to demand, you are able to sell your condo for $850,000 — and won’t have to pay any capital gains tax. But why?
Because you lived in your condo for a total of two years in the past five years, the residency requirement is fulfilled. And since you are married, you are exempt from capital gains tax on your first $500,000 in profits — with a total profit of $450,000 ($850,000 – $400,000), you are exempt from paying any capital gains tax related to the sale.
The other important thing to note is that you can only take advantage of this tax exemption once every two years. In other words, if you are trying to sell two homes at once, even if you meet the residency requirements on both, you will only be able to qualify to sell one of the homes tax-free.
Capital Gains Tax Rates
Capital gains are taxed depending on how long you have owned the asset. Short-term capital gains, paid on assets that you owned less than one year, are taxed as ordinary income — with rates as high as 37%. Long-term capital gains tax rates are 0%, 15%, or 20%, with tax rates applied according to your income and tax filing status.
If you have to pay long-term capital gains tax, the amount you pay will ultimately depend on your income tax bracket; however, it is important to note that it won’t be taxed exactly the same as your ordinary income.
The Tax Cuts and Jobs Act of 2017 essentially separated these two types of tax brackets. Here’s how long-term capital gains tax brackets break down for the tax year 2021, based on how you file your taxes:
If your income is $40,400 or less: 0%
If your income is $40,401 – $445,850: 15%
If your income is $445,851 or more: 20%
Married Filing Jointly:
If your income is $80,800 or less: 0%
If your income is $80,801 – $501,600: 15%
If your income is $501,601 or more: 20%
Heads of Household:
If your income is $54,100 or less: 0%
If your income is $54,101 – $473,750: 15%
If your income is $473,751 or more: 20%
Married Filing Separately:
If your income is $40,400 or less: 0%
If your income is $40,401 – $250,800: 15%
If your income is $250,801 or more: 20%
Reali’s innovative Trade-In program allows you to move into a new home before your old one even sells. The process is stress-free, simple, and convenient. Reali’s centralized and streamlined process allows you to enjoy your new home, as well as significant cost savings.
Simply get pre-approved through Reali Loans and find your new home, then we’ll make a cash offer to buy it on your behalf. We’ll sell your old home, and then you buy your new home back from us.
Ready to sell? We’re here to help. Explore how Reali agents can help you sell your home for top dollar.
Reali, Inc. does not provide legal, investment, accounting or tax advice, please consult a licensed attorney, financial planner, CPA or tax professional on these ‘tips’ and any information or opinions contained herein.
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