Are you wondering if you’ll have to pay capital gains tax on your home sale?
Many people do not know that a large portion of homeowners who sell their homes can avoid capital gains tax on their home sales.
The home-sale exemption, also known as the home sale capital gains tax exclusion, allows homeowners in the United States to claim a home-sale exemption from the sale of their primary residence.
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How Much is Capital Gains Tax on the Sale of a Home?
When selling your primary home, you can make up to $250,000 in profit or double that if you are married, and you won’t owe anything for capital gains.
The only time you will have to pay capital gains tax on a home sale is if you are over the limit.
Many sellers are surprised that this is true, especially if they have lived in their homes for years.
This is because, before 1997, the only way you could avoid paying taxes on the profits from a home sale was to use it to purchase an even more expensive house within two years.
Taxpayers over 55 had other options. They could take a once-in-a-lifetime tax exemption of up to $125,000 in profits. This required Form 2119 to be filed too.
Thankfully, in 1997, the Taxpayers Relief Act was introduced, and millions of residential taxpayers had the burden lifted.
The lifetime option was replaced with the current sale of home exclusion amounts. This change makes it easier for homeowners to sell their current residence if they want to.
What is the Capital Gains Tax Rate When Selling a Home?
The long-term capital gains will be taxed at 0%, 15%, or 20%, depending on the investor’s taxable income and filing status, excluding any state or local capital gains taxes.
For assets held less than one year, short-term gains are taxed at regular income rates, which may be as high as 34% based on the taxpayer’s individual income.
As a result, investing for more than a year is recommended to benefit from reduced long-term capital gains tax rates.
Do I Have to Buy Another House to Avoid Capital Gains?
No, but there is a limit. Profits earned on the sale of real estate are regarded as capital gains.
However, suppose you utilized the property as your principal residence and met specific additional criteria.
In that case, you may deduct up to $250,000 of the gain ($500,000 if married), regardless of whether you purchase another home.
How Can I Avoid Capital Gains Tax on a Home Sale?
If you used the rules before 1997, it does not mean that you are disqualified from claiming the exclusion on any sales now.
You also don’t have to worry about using your profit from the sale of your home to purchase another home, either.
Another great benefit is there is no limit on the number of times you can claim the home-sale exemption. Usually, you can keep those tax-free profits each time you sell one of your homes.
There are some requirements that have to be met to avoid paying capital gains tax after selling your home.
1. The property has to be your principal residence (you live in it). If it is an investment property, you will have to follow the usual capital gains rules.
2. You have to live in the residence for two of five years before selling it. (This is also a sneaky way of saying you can only sell a home once every two years at the minimum).
The good news is, if your gain does not exceed the limit, you don’t have to file anything with the IRS.
Capital Gains on Sale of Second Home
If you own multiple homes, it may not be as easy to shelter sale profits as it was in the past.
The Housing Assistance Act of 2008 was designed to provide relief for homeowners on the edge of foreclosure, yet it could cost the owners when they decide to sell.
You used to be able to move into the second property, make it your primary residence, live there for two years, and profit from the gains.
Even when your second piece of real estate is converted into your primary home, you will be taxed on part of the gains based on how long the home was used as a second home and not the primary residence.
Rules for Married Couples
Married couples can profit more from the rule; however, their sales may not always be tax-free.
Either spouse can meet the ownership test. For example, it’s okay if you owned the home for two years but only added your husband when you were married six months ago.
Then, you will pass the ownership test with flying colors.
However, when it comes to the “use test,” both partners have to pass. The good news is if you were unwed and living together for a period that equals two years, the IRS will allow you to pass.
Nevertheless, if that isn’t the case, you won’t get the tax exclusion unless you wait until he meets the two-year mark too.
Keep in mind the two-year eligibility rule when getting to know your spouse. Remember, you are only able to sell a home once every two years.
Therefore, if your new spouse sold a home in the past two years, it will prohibit you from being able to sell until their two-year time span expires.
Determining the Sale of Home Exclusion Amount
Now, once you decide you are eligible to sell and meet the exclusion rule, you have to do some math, so you can avoid pulling out your checkbook after you sell.
But, first, keep in mind that you have to think about more than the money you received during the sale. It is important, but other numbers play a factor too.
You have to consider your gain. It is what decides whether you will have a tax bill.
For example, you could sell your home for $750,000 and not owe any money because you didn’t gain more than $250,000 ($500,000).
1. To get to your gain amount, establish your basis in the home. (Usually, this is what you paid for the residence and the capital improvements that you made)
2. Compare the basis amount to what you received from the sale (excluding commissions and other expenses). This number provides you with the gain on the sale.
Usually, you will find that you got some profit, but it isn’t large enough for you to have to pay taxes on it.
Remember that improvements increase your basis, so a smaller portion of the selling price is considered a gain.
For example, the American Relief Act is 20% for higher-income taxpayers and 15% for many individuals and 0% for some sellers.
Partial Exclusion is Still Good
Even if you cannot meet all of the tests, it does not mean that you will not get any sort of tax break at all.
If you are selling because of special conditions, you are eligible for a prorated tax-free gain.
In this case, you would calculate the fractional amount of time that the two-year use test was met.
Special Rules – Special Circumstances
Military members also have special home sale considerations. Thanks to redeployments, soldiers can find it hard to meet the residency rule and end up paying taxes when they sell.
However, in 2003, it was put into law that military personnel are exempt from the two-year use requirement for up to 10 years, allowing them to qualify for the full exclusion when they have to move to fulfill their duties.
In 2008, a new rule was put into place for those who sell after a spouse dies. Instead of having to sell during the same year the spouse passes, a widow/er can take up to two years to sell and have up to $500,000 excluded from taxes.
Therefore, if you want to sell your home, consider what we have discussed today. You may find out that you won’t have to pay Uncle Sam a dime when you sell your home.
How to File Taxes for Capital Gains Home Sale
Keep in mind, if you file online, they will ask you the correct questions to help you claim the capital gains deductions you qualify for and guarantee you will receive the largest refund ever.