Understanding Capital Gains During a Home Sale

Homeowners have many tax considerations. Aside from paying routine property—and, if applicable, school—taxes throughout ownership, there are sometimes taxes to be paid when selling a property. This tax is called a capital gains tax. Planning for capital gains taxes should ideally begin long before planning to sell a home. Here's a rundown of what all homeowners should know about capital gains tax when selling their home.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.

What Is Capital Gains Tax?

Homeowners who sell their homes for more than they paid for may have to pay capital gains tax on the profit. For many people, the capital gains tax is a non-issue. People who bought their homes many decades ago or during a buyer's market and sell at a high price may end up owing extra money when they sell.

For example, a single taxpayer buys a house for $250,000 when the market is low. Several years later, the real estate market has soared, making their house now worth $550,000. Capital gains would be $300,000; this amount would be subject to capital gains tax.

How Much Has to Be Paid?

According to the IRS, the tax rate for most taxpayers will be contingent upon taxable income. The tax rate for capital gains is at 0 percent, 15 percent, or 20 percent. For most individuals, this rate will be no higher than 15 percent. While there are a few exceptions that require a higher rate, most people won't have to pay if they fall below taxable income thresholds. How much is subject to capital gains tax will depend on whether the home seller is a single filer or joint filer for income tax returns. Taxable income levels may change over time, so it's always best to check with current IRS information and rules when determining tax rates for capital gains.

Ways to Bring Down Capital Gains Tax When Selling

Fortunately, for those who do make a substantial profit on their home, there are several ways they can minimize, or at least reduce, the amount of capital gains tax they'll owe. The can:

• Ensure the property is considered a primary residence for at least two of the previous five years—it doesn't need to be consecutive. Otherwise, it may be taxed as income and ineligible for capital gains exemptions.
• Plan to own the home for at least two years. Anything shorter than that will be considered “short-term capital gains” and taxed at a higher rate than “long-term capital gains.”
• Keep track of money spent when selling a home, including but not limited to marketing expenses, closing costs, real estate fees, and other expenses relating to the home's sale.
• Track improvements. Any money spent on improvements during the time the home is owned that raised the property's value can be deducted. Keep bills, sale receipts, credit card statements, or other documentation to show when the improvements were made. These do not necessarily need to be new improvements.

There are no exclusions for investment properties for the capital gains tax. To qualify, the homeowner must have used the house as a primary residence, and only one residence applies to any exclusions. Other exclusions are available for investors who immediately reinvest or “swap” properties, but sellers need to talk to a financial advisor to ensure it's done correctly.

Homeowners should keep in mind that only their net gain from the house sale will be taxable if required to pay capital gains tax. Sellers can deduct all transaction costs and commissions associated with the sale of the house.

Selling a home can be a complicated process. However, armed with the proper knowledge, homeowners can successfully minimize or eliminate any potential extra taxes they might owe upon the sale's completion.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.