The Tax Implications of Selling a House – How to Minimize Your Capital Gains Tax

July 16th, 2021
Homes

Selling a home is by no means an easy process, and that’s excluding the accompanying bureaucratic hurdles and tax considerations. You need to market the house, find the right buyer, and negotiate the price, before dealing with the taxes. 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.

Short-Term Gains vs Long-Term Gains

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. The tax rate will be either 0%, 15%, or 20%, based on the profits. 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.

Primary Residence vs Secondary Residence

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: 1) lived in for two of the last five years; 2) owned for two of the last five years.

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 considered your main home, and thus the primary residence. This classification is important because you can exclude a large sum from the capital gains tax if you sell your primary residence.

Capital Gains Tax on 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 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 of the gains from 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 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 sell 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.

Deductions for Home Expenses

There is an additional method you can use 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.

Minimize capital gains real estate

Substantial physical improvements to your home—even if you did them years before you prepare to sell you home—will add to your cost basis and reduce your capital 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 that have a life expectancy of less than 1 year when installed to your cost basis.

How Does Tax on Inherited Property Affect All of This?

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 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. 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.

A Short Rundown

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.

The tax implications of selling a house are not something you should ignore. They are a major factor in how much money will be left in your pocket once the deed is done. Doing some calculations and selling to the right buyer at the right time can substantially increase your profits.

SleeveUp Homes has been in the real estate business for years, and we can advise you about the tax implications of selling a house. We know how to avoid foreclosure, especially if you’re a distressed homeowner who is behind on mortgage payments. We’re not realtors or wholesalers, we buy direct from you and give you the fairest possible price for your property. If you don’t want to go through the process of selling your home on your own, or you need to avoid foreclosure, SleeveUp Homes can help. We buy and rehab homes directly from homeowners, and we perform any repairs required to get a home into sale condition. We cut out the realtors and wholesalers so that we can pay top dollar for your house regardless of its condition.

If you’re ready to sell your home for a fair price without the hassle, contact us today to get an offer.