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Capital Gains When You Sell A House
1 Mar 2021
Are you currently planning to sell your house? If your answer is yes, you should know that selling a capital asset may involve paying capital gains tax. According to the Internal Revenue Service (IRS), almost everything an individual owns classifies as a capital asset.
The tax applies whether the asset you’re selling is a personal property or one that’s bought as an investment. When you sell an item for an amount that’s more than you paid for, the price difference is what you call a capital gain. And when individuals earn a capital gain, they need to report it as part of their taxes.
To fully understand this topic, continue reading this article and know about capital gains when you sell a house.
Capital Gains Tax Definition
The term capital gains tax refers to an amount you must pay when you sell a capital asset that has a greater value compared to its original price. Nonetheless, various assets have different tax rates based on what they are and depending on the current situation.
As previously mentioned, capital gains tax applies to almost all your assets. This levy extends to items such as investments, pieces of furniture, and collectibles. It likewise applies to vehicles, though collectible cars may be exempt since owners usually experience a loss when they sell their vehicles.
Capital gains—as well as losses—can vary quite a bit. For instance, there are long-term capital gains, as well as short-term capital gains. For the most part, long-term capital gains are taxed at lower rates (up to 20 percent) whereas short-term capital gains are generally subject to higher rates (up to 37 percent). Since capital gains are amalgamated in with taxable income, a tax calculator is necessary to determine how much your tax return will be impacted.
Moreover, capital gains tax covers home sales, which this article will further discuss. Keep in mind that an individual only pays the tax after selling the property. And before settling the amount, you must distinguish first if you need to cover short-term or long-term capital gains. The next section will discuss the difference between the two terms.
Federal Tax Rate
The capital gains tax rate varies per individual. Likewise, you need to discern if what you’re settling is a long- or short-term capital gain.
When referring to long-term capital gains tax, it applies to revenues from the sale of a property or asset owned for more than a year. The tax rate that applies is either 0%, 15%, or 20%. As mentioned earlier, the tax rate varies, and computation will depend on the person’s filing status and taxable earnings. Compared to short-term tax, long-term one has lower rates.
Meanwhile, short-term capital gains tax covers profits earned from the sale of a property or asset owned for a year or shorter than a year. This specific tax rate is equivalent to your standard income tax rate.
Following this, the IRS usually permits a real estate tax rate exclusion of approximately USD$250,000 if you’re single. For married couples, the amount is higher at USD$500,000. Also, note that individuals belonging to the lowest tax category typically don’t have to settle any amount on long-term capital gains tax.
To enumerate, suppose you’re planning to sell the house that you owned for more than 10 years. The original price you paid for the property is USD$300,000, and you’re going to sell it for USD$900,000. If you’re married, USD$500,000 of the USD$600,000 profit you earned may be free from capital gains tax (CGT).
How to Avoid Capital Gains Tax
Many are wondering if it’s possible to avoid this type of tax. And the good news is there are several ways you can reduce or get rid of your obligation. Furthermore, please take note that you need to reside in your house for roughly two years out of the last five years to classify it as your primary residence.
Single individuals can avoid paying $250,000 or $500,000 for married couples if they satisfy these criteria:
You Resided in the House for Two Years
Keep in mind that capital gains only apply to your primary home. You need to reside in the house for approximately two years out of the last five years before selling it and becoming eligible for a tax exception. Note that the years you resided in the house don’t have to be continuous.
You Own the Property for Two Years
To appeal for an exception, you must own the property for nearly two years. If that isn’t the case, you’ll have to pay the short-term tax rate. However, there are others who find a way to avoid or defer paying the tax by acquiring a property through a 1031 exchange.
In detail, the 1031 name comes from IRS Section 1031. The code describes a like-kind exchange of one investment property to another. While the provision pertains to business and investment properties, it also covers primary homes under specific terms.
You’re Eligible for a Tax Exception
And finally, if taxable gains apply on the sale of your house, you can still withhold some of the cost if you’re selling your home due to health reasons, work, or unexpected events. However, in instances you already filed for a capital gains exception in the last two years, you can’t apply again for another tax exception.
Again, it’s essential to remember that capital gains exemption is only eligible to your primary home. Suppose you own an investment property or a second residence. If you plan on selling them, then full CGT will apply to the said properties.
Factors Affecting Capital Gains Exclusion
While the above elements qualify you for a tax exception, take note of some of the factors that entail you to shoulder the whole capital gains. The first factor is when the house wasn’t your principal residence. This aspect means that you don’t consider said property as your domicile or permanent dwelling.
Another factor is if you owned the property for less than two years in the five-year period before selling it. The same holds true if you reside in the house for less than two years in the five-year period before selling it.
Additionally, you need to settle the whole capital gains if you’re an individual subject to expatriation tax.
Capital Gains when you sell a house – Final Thoughts
In the long run, the tax amount you need to settle will depend on factors such as your salary, status, and the exact selling price of your asset. Keep in mind that CGT is only one of the various concerns you’ll encounter with homeownership. Also, people possess distinct financial situations, and it’s best to consult a professional tax advisor or a licensed financial expert before rendering any significant financial decision.
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