Capital Gains Taxes & Selling Real Estate Property
What you need to know about capital gains taxes when selling your home or investment property.
Selling a property—whether it’s your home or an investment—comes with financial considerations, and one of the most important is how it might affect your taxes. Capital gains taxes can apply when you sell for more than what you originally paid, but the specifics depend on the type of property, how long you’ve owned it, and whether you meet certain IRS exclusions. Let’s break down what you need to know so you can plan your next steps with confidence.
What Are Capital Gains Taxes?
When you sell an asset like a house for more than you paid for it, the profit is called a capital gain. The IRS taxes those gains based on your income, how long you owned the property, and other factors.
There are two types of capital gains:
Short-Term Capital Gains: If you’ve owned the home for less than a year, any profit is taxed as ordinary income.
Long-Term Capital Gains: If you’ve owned the home for more than a year, the profit is taxed at a lower rate, depending on your income level.
But don’t worry—most homeowners don’t end up paying these taxes because of a key rule called the home sale exclusion.
The Home Sale Exclusion
The IRS allows you to exclude a significant amount of profit from capital gains taxes if you meet specific criteria:
$250,000 Exclusion for Single Filers
$500,000 Exclusion for Married Couples Filing Jointly
To qualify for this exclusion, you must meet these requirements:
Ownership and Use: You must have owned the home and lived in it as your primary residence for at least two of the last five years before the sale.
No Recent Exclusion Use: You haven’t claimed the home sale exclusion on another property within the past two years.
For example, if you’re married and sell your home for a $400,000 profit, you likely won’t owe any capital gains taxes because it’s under the $500,000 exclusion limit.
What Happens If You Don’t Qualify for the Exclusion?
If you don’t meet the criteria for the home sale exclusion, you may owe capital gains taxes. Here’s when that might happen:
You’ve owned the home for less than two years.
The property was a rental or second home, not your primary residence.
You’ve already used the exclusion on another property within the last two years.
In these cases, your capital gains will be subject to the standard tax rates:
0%, 15%, or 20% for long-term gains, depending on your income.
Your ordinary income tax rate for short-term gains.
However, you may still be able to reduce your taxable gains by factoring in the cost basis of your home.
Adjusting Your Cost Basis
The cost basis is essentially the amount you invested in the home. It starts with the price you paid for the property but can be adjusted upward if you’ve made significant improvements.
Here’s what can increase your cost basis:
Major renovations (e.g., a kitchen remodel or new roof)
Additions, like a deck or extra bathroom
Structural improvements (e.g., replacing HVAC systems or plumbing)
By increasing your cost basis, you reduce the taxable gain when you sell your home. Be sure to keep detailed records and receipts of any improvements to document these adjustments. While the IRS does not automatically require verification when you report an adjusted cost basis, you should be prepared to provide evidence if requested.
Planning Ahead for Capital Gains
If you’re thinking about selling your home, here are a few tips to help you prepare and minimize your tax liability:
Know Your Numbers: Calculate the potential profit from your home sale and whether it falls within the exclusion limits.
Keep Good Records: Document all purchase costs, improvements, and related expenses to adjust your cost basis.
Time the Sale Wisely: If you’re close to meeting the two-year ownership and use rule, consider waiting to sell so you can qualify for the exclusion.
Consider a 1031 Exchange: If the property is an investment, you might defer capital gains taxes by using the proceeds to buy another investment property.
Talk to a Professional: Selling a home can have long-term tax implications, so consult a financial advisor or tax professional to explore your options.
Selling Your Home with Confidence
Understanding capital gains taxes doesn’t have to be intimidating. By knowing the rules and planning ahead, you can make informed decisions that save you money and set you up for success.
At Vector Wealth, we’re here to guide you through every step of your financial journey, including how major life transitions—like selling your home—fit into your bigger picture. If you’d like help planning for your sale or have questions about your specific situation, we’re just a call away.
Let’s make sure your next move is a smart one.
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