Understanding Capital Gains When Selling Your Home

Home sellers may not consider capital gains until they're in the final stages of the home sale process, when they are able to calculate their taxes. Learn more about the principles of these capital gains, who may be exempt, and what can be done to possibly avoid paying them.

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

How Are Capital Gains Taxed?

Capital gains are most often taxed at 15%. This means that if the home was purchased for $100,000 and resulted in a profit of $100,000 by the time it was sold, then capital gains would take $15,000 of the profits. Capital gains tax applies to any asset that may appreciate, and is added to a homeowner's income to determine the rates of taxation.

If the seller made less than $39,375 per year, they would be exempted from the obligation of capital gains. Any income between $39,375 and $434,550 would be taxed at 15%. Finally, those who make more than $434,550 would be taxed at 20%. These numbers do change fairly regularly to account for inflation, but the brackets will remain roughly the same.

Do All Sellers Pay Capital Gains?

The government has introduced a number of rules and regulations into the tax code to encourage people to purchase property. The best incentives usually go toward first-time buyers, but there are a variety of rules that make it easier to sell a primary residence.

The government allows each owner to deduct up to $250,000 worth of capital gains per owner, so long as the owners have held the property for at least five years and lived in the home for at least two years. This means that a married couple who has resided in the home for five years could deduct up to $500,000 of capital gains. These time blocks do not have to be consecutive, meaning the owner(s) can rent out their home for half of the year and live in it for the other half, so long as the total adds up to 24 months over the course of 60.

Can Sellers Make Any Other Deductions?

Sellers can make a number of deductions if capital gains do apply to their home sale. This includes any expenses associated with either the sale or purchase of the home such as closing costs, staging fees, etc.

The point of these deductions is to either raise the purchase price of the home or to lower the sale price of the home, bringing the two numbers closer together and lowering the taxable profits. Sellers are highly encouraged to speak with a real estate expert to determine which costs are deductible.

Can Capital Gains Be Avoided?

There are a few ways to avoid or defer the payment of capital gains:

• Capital losses: Capital losses can be used to cancel out capital gains. If sellers have an asset that has significantly decreased in value, such as a stock or second property, they can sell this asset in addition to their home in the same year and use the loss to eliminate the gains.
• Switch residences: If the seller owns two properties and their second home has appreciated significantly, one option is for the owners to move into the more valuable property. They would need to live there for at least two years to qualify for the $250,000 deduction.
• 1031 exchange: A 1031 exchange involves purchasing a property that is of similar value to the property sold. For example, someone sells a home for $1 million and then buys another home for $1 million. In this case, sellers defer capital gains until they sell a property for its appreciated value.

How Does Depreciation Affect Capital Gains?

Homeowners who rent out their homes who claim depreciation will need to understand how this affects their capital gains. The more depreciation, the more it will increase the capital gains. 

While capital gains taxes do not apply to all home sales, there are plenty of situations where sellers need to take them into account. Whether it's because their home appreciated more than $250,000 per owner, or they need to sell their home in a hurry, the details of each sale will differ. Understanding how it works is the first step so sellers don't overpay on their profits.

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