Selling a home is by no means an easy process, and that excludes the accompanying bureaucratic hurdles and tax considerations. Before dealing with the capital gains tax on property, you need to market the house, find the right buyer, and negotiate the price.
In this article, we’ll explain the tax implications of selling a house and give advice on the tax strategy that can save you the most money.
The first factor that will impact your taxes is whether the profits from the sale are classified as short-term or long-term. The profits will be considered short-term if you sell a house that you’ve held for less than a year, while the gains from selling a house that you’ve held for more than a year are considered long-term.
This distinction is important because long-term gains are taxed more favorably. Based on the profits, the tax rate will be either 0%, 15%, or 20%. Short-term gains are taxed as ordinary income, which means that they depend on your personal income tax rate, which can range from 10% to 37%.
Further, as the gains from the sale are added to your yearly income, it’s highly likely that it will push you to a higher tax bracket than you already were in. As far as the tax implications of selling a house go, your best option is to sell only after you’ve held the house for more than a year.
Total taxable income is how you determine how much you need to pay and what tax bracket you fall into. It is the amount on which your household pays income taxes. There are three steps to calculating your taxable income:
When reporting your income, it is important to include short-term capital gains - that way, you’re paying capital gains tax on a property together with other incomes. Long-term capital gains are taxed separately from regular income and don’t push you to another tax bracket.
The second factor that will impact the taxes you have to pay is whether the home you are selling is considered your primary residence or not. Per IRS rules, your primary residence is the home you’ve:
You don’t have to live in and own the home consecutively, but both need to have happened in the same 5-year time frame. Further, you can only have one primary residence. Even if you somewhat equally divide your time between two homes and both would meet the conditions for a primary residence, only one can qualify.
The home you spend most of your time in will be your main home and, thus, your primary residence. This classification is important because you can exclude a large sum from the capital gains tax if you sell your primary residence.
If the value of your house rose from the time you bought it and the time you sold it, you are liable to pay capital gains tax on a property based on the profits, regardless of whether the profits are considered short-term or long-term gains. However, that’s where the primary residence category comes in.
If you are single and selling your primary residence, you can exclude $250,000 capital gains taxes. If you are married and you and your spouse file jointly, you can exclude $500,000. So, generally speaking, if you bought a home for $150,000, made it your primary residence, and sold it for $300,000, the $150,000 you made is your capital gain.
When you report the sale and proceeds at the end of the year, you’ll need to fill out the worksheets in IRS Publication 523, Selling Your Home.
However, you don’t need to pay any capital gains tax on a property, as the profit did not exceed $250,000 or $500,000. On the other hand, if the gains are larger than $250 000 (or $500,000 if married and filing jointly), you will be taxed 0%, 15%, or 20% based on the profits.
There is one additional exception to the capital gains exclusion – you can only qualify once every two years. For example, let’s say you bought your home in 2010 and lived there until 2019, making it your primary residence. In 2019 you inherited a home and started living there full-time.
In 2020 you sold your old home, and as it’s still your primary residence, you are exempt from the capital gains tax. By 2021, your new home will officially be considered the primary residence, but you wouldn’t be able to qualify for the exemption until 2022 because 2 years have not passed since the previous sale.
The tax implications of selling a house that is not your primary residence largely depend on whether the profits are considered short-term or long-term capital gains. In general, the gains are short-term if you’ve owned a property for less than a year before selling it.
As discussed previously, long-term capital gains qualify for taxes based on capital gains tax rates - usually lower than regular income taxes. If you’ve held your home for more than a year, the profits from the sale will be considered long-term capital gains.
There’s no exemption to the capital gains tax on secondary property like there is with a primary residence, but still, the capital gains tax rate is generally lower than your regular income tax, especially if the gains were to push you into a higher tax bracket.
You can also use another method to reduce the taxes you pay. As your gains are calculated by deducting the cost basis of your property from the price you sell it for, you can lower your taxes by increasing the cost basis, thereby reducing your gains.
The cost basis is the price you paid for the home plus the value of any improvements and additions you made and the fees and expenses associated with the purchase itself. So, if your initial cost basis was $150,000, but you’ve added a pool and renovated the kitchen, totaling to $30,000, and your closing costs were $5,000, your new cost basis is $185,000.
You can even add smaller improvements, like installing new windows or a central heating system, to your cost basis. However, you can’t add the cost of repairs that are necessary to make the home livable but don’t add to its value or prolong its life.
This would include things like fixing leaks, replacing broken hardware, or filling holes and cracks. In addition, you can’t add the cost of improvements with a life expectancy of less than 1 year when installed to your cost basis.
Capital gains tax on property has no age-based exemptions as of the late 20th century. Before 1997 the government allowed people over the age of 55 to exempt up to $125,000 from the property sale to better prepare for retirement. Today, capital gains exemption for seniors is inadmissible - but the rule of “up to $250,000” ($500k for singles) still applies, like with any taxpayer.
Capital gains tax on a property can be deducted only under one special circumstance - capital gains exemption for seniors is possible for those taxpayers who have back-end retirement accounts.
Retirement accounts are usually front-ended, meaning that you can deduct the money you invested in these accounts only on the year when you invested. However, if you have a back-end retirement account, you can pay capital gains tax on property as the difference between the money you invested and the money you withdrew.
The tax implications of selling a house that you inherited are slightly different than if you had bought it personally. The factors we listed – whether you made it your primary residence before selling and whether the profits will count as short-term or long-term gains – still apply.
However, what differs is the cost basis that is used to calculate the gains from the sale. For most properties you buy, the cost basis is the money you initially paid plus any capital investments you made to increase the value of the property, minus the allowable depreciation.
Once you deduct this basis from the amount you sell the house for, you have your gains. However, the cost basis is calculated differently for a house you inherit. It is based on the fair market value of the property at the time of the prior owner’s death and not how much it was initially worth.
So, if you inherit a house that was bought in the 1980s for $50,000, that is not the cost basis that will be used to calculate the gains if you sell it. This is called a step-up in a basis and is a good thing if you intend to sell the inherited property.
If the basis of the house that was bought for $50,000 is stepped up to its fair market value, let’s say $300,000, and you sell it for that amount, you don’t have to pay any capital gains tax on a property. Conversely, if the cast basis was still $50,000 and you sold it for $300,000, you’d have to pay capital gains tax on $250,000.
Selling a home soon after you inherit it and before its value goes up can be a good option. Restoration companies like SleeveUp Homes will buy inherited homes for a good price without charging you a realtor’s commission, and you don’t have to invest in repairs or pay capital gains tax. In essence, it can be pure profit.
Contact us and request an offer. That’s the only way to check what we provide - quick and easy home sale, guaranteed $10K more than others, and, most importantly, a reliable buyer.
Taxes are mostly unavoidable, but they’re not all built the same. Your best option is if you are selling a house that is your primary residence, as you can exclude $250,000 or $500,000 from your capital gains tax.
If you are not selling a primary residence, you should check whether the profits will qualify as short-term or long-term gains – the tax rates for short-term gains are usually higher. Finally, the same rules apply to a house that you purchased or inherited, with the exception of how the cost basis is calculated.
If you want to sell fast and are worried about how long the traditional process takes, and the commission and fees involved, consider working with SleeveUp Homes.