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Avoid Capital Gains Tax When Selling a House

Avoid Capital Gains Tax When Selling a House

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Avoid capital gains taxes when selling a house

There is a lot of pride in owning a property, whether it is a primary home or a holiday bungalow. It is especially rewarding when proper compensation is paid for the property. But while a high sales price may be exciting in the moment, there is usually a potential downside. As a capital asset, all profits from the sale of your property are taxable. It’s important to understand how capital gains affect your home and how you can reduce their sting. A financial advisor may be able to help you if you’re selling an asset, so consider using SmartAsset’s free advisor search tool today.

What are capital gains taxes?

From personal belongings to investment products, almost all of your possessions are capital. This includes assets such as cars or real estate and investments such as stocks or bonds. Let’s say you decide to sell one of these assets, such as your home. The profit you get from the sale may be subject to capital gains tax.

Long-term capital gains arise when you sell assets that have been in your possession for more than one calendar year. Short-term capital gains arise from the sale of assets held for less than a year. Although tax rates vary, long-term capital gains are generally taxed less than short-term capital gains.

When do you have to pay capital gains tax?

It is important to note that capital gains taxes only affect realized profits. This means it applies when you sell an asset for more than its basis. If the gain is unrealized, meaning you still own the item, this special tax will not apply.

The long-term capital gains tax rate varies between 0, 15 and 20%. There are a few higher prices for certain products, but they do not apply to home sales. In contrast, short-term capital gains are taxed as ordinary income, which can be much higher. Income taxes vary between 12 percent and 37 percent.

Do you have to pay capital gains tax on real estate?

Avoid capital gains taxes when selling a house

Avoid capital gains taxes when selling a house

Taxes come into play almost every time you make money. So if you make a profit from the sale of your property, you will likely be subject to capital gains tax. For example, if you bought a property six years ago for $200,000 and sold it today for $300,000, your profit would be $100,000. You should report the sale and potentially pay capital gains tax on the resulting profit. The exact tax amount then depends on your adjusted gross income (AGI), filing status, and length of ownership.

But before you can even calculate your debts, you need to determine your tax base. The basis is the amount of money you invest in the property, also known as capital investment. The tax basis for selling an apartment depends on the circumstances in which you live and own it. There are three scenarios:

  • If you bought your home: The cost basis starts with the purchase price and includes certain closing costs. The cost basis is also affected by renovation and construction costs, which increase the property’s value or longevity. Finally, if you’ve paid taxes meant for the seller, those will also add up.

  • If you inherit your home: The cost basis starts with the home’s value at the time the previous owner leaves. This is the so-called step up. This is because you don’t have to factor in capital gains taxes until you buy the property.

  • If your home was a gift: The cost base of the gifted home remains uniform. The cost basis of the previous owner therefore remains the basis of the new owner. However, there may be some exceptions. There are also potential gift tax implications, as you must report all gifts over $16,000 (starting in 2022) to the IRS. This is the annual gift tax exclusion amount that goes toward the lifetime gift and estate tax exclusion limit. As of 2022, it will be $12.06 million for individuals and $24.12 million for couples.

One caveat, however, is that the IRS offers a tax exemption if the property is your primary residence. However, you must prove that you own the house and have lived in it for at least two years. The latter need not be consecutive.

How to avoid capital gains taxes when selling a house

If you want to make a profit on the sale of your house, you owe capital gains tax. However, there are some legal methods to minimize these taxes, such as:

  • Rule 2/5 years: You don’t have to live in the house for years in a row, but cumulatively. This will help you meet the usage and ownership tests. As a result, you may be eligible for an exclusion of up to $250,000 as an individual or $500,000 as a joint filer.

  • Conditions for partial exclusion: According to IRS Publication 523, certain situations may make you eligible for the profit exclusion. As long as you sold the home due to work, health or an “unforeseen event”, you can exclude some of your taxable income.

  • Hold on to your home improvement receipts: The cost base of your property includes more than its purchase price. It also includes the improvements you have made. The higher your cost basis, the lower your potential exposure to capital gains tax.

Bottom line

Avoid capital gains taxes when selling a house

Avoid capital gains taxes when selling a house

Everyone wants to make a profit when they sell their home. However, there are costs to consider, including capital gains tax. However, the short-term profit tax will likely result in a higher tax rate. So it can be profitable to hold the property long enough to qualify for long-term capital gains tax. But remember that the rules vary. Different types of properties can also cause changes to your potential taxes, so make sure you do your research before making a decision.

Tips for investing

  • Navigating the ins and outs of capital gains taxes can be challenging. If you want to understand your tax liability when selling your home, ask for professional help. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three financial advisors in your area, and you can interview your advisor for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • At some point you will have to pay capital gains taxes. But that doesn’t mean you can’t find other areas of your life to cut costs. If you’re an investor looking to minimize expenses, consider checking out online brokerages. They often offer low investment fees, helping you maximize your profits.

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The post How to avoid capital gains tax when selling a house appeared first on SmartAsset Blog.


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