One of the biggest and most exciting thing that you can purchase is buying a house. And if one day you decide to sell it, there are a couple of perks to one and of them is the capital gains tax exclusion. Now what is this capital gains tax exclusion and how can you benefit from it? Let this article help you answer that, do read on for more!
What is Capital Gains Tax?
As time goes, we accumulate a number of capital assets of our own. These could be cars, stock shares, and bonds. The moment you buy a house, it is considered as your capital asset too simply because of its significance. Now when you sell this property for more than you have purchased it for, it is then called your capital gains.
If you sell your car more than the price you have paid for, you are obligated to report it to the IRS or Internal Revenue Service whereas when you sell a house, you are excluded from capital gains tax. This means you are not given any tax as long as you and your house fit the criteria that is being required of you.
How Do You Qualify for Capital Gains Tax Exclusion?
There are a number of ways in which you can qualify for capital gains tax. You can expect a good profit for your house but you must qualify in order to be exempted from capital gains tax among others.
- You must own the house at least 2 years or more – in order to qualify, one of the most important requirement is that you must own your house for more than 2 years. Your house cannot be “flipped” as you can be subjected for a short-term capital gains tax. However, this type of tax is applied if you own the house for less than a year.
- You have resided in that house for at least 2 years – besides owning it for two years, you must also be the primary resident of it. You must live in there for at least two years even if it’s not consecutive as long as the months add up to 2 years.
- You haven’t done any previous selling of a house – you can be exempted from capital gains tax if you haven’t sold any house in the last two years as well.
So as long as you have done things accordingly and follow the requirements needed, you can repeat the procedure over again. Although there is no shortage of how many times you can sell, there are some limitations to it. One of which is that you must be able to keep records of how much you have purchased their home for and the expenses you have spent on repairs and renovations. You must also be aware of the requirements you passed for the required period so you can take advantage of the capital gains tax exemption.
How Much is Excluded from Your Capital Gains Tax?
The IRS will allow you a certain amount that you can be excluded of from your capital gains:
- If you are single, $250,000 of capital gains on real estate.
- If you are married and filing jointly as a couple, $500,000 on capital gains on real estate.
How to NOT Qualify for Tax Exclusions?
While this is good news, there are also downsides to it as your capital gains tax exclusion runs out the moment you fail to qualify. This means you have to pay taxes if you are among the following:
- If you are not residing in the house that you are selling or have sold.
- If you own the property less than 2 yrs over the 5 yr period before you sold it.
- If you did not live or resided int he house for two years before you sold it. But if you are someone who is int the military, disabled and/or belong to the foreign service or intelligence community, you might just be able to avoid this under IRS publication 523.
- If you claimed money from other capital gains tax on another house within the 2 year period before the sale of the house you currently have.
- You acquired the house through the same exchange (swapping an investment property for another) in the last 5 years.
- If you are subject to expatriate tax/taxes.
Long-term and Short-term Capital Gains
Now keep in mind that the period of you owning your house matters when it comes to taxes. It could make a big difference in terms of gains depending on the value of your house and your tax bracket.
For short-term capital gains, the assets should be owned for at least a year or 6 months. The rate of your capital gains tax will also be equal to your tax bracket.
Long-term capital gains are for the assets you owned for one year or more. The capital gains tax you have will depend on your tax bracket too. You could potentially not pay anything but if you have a higher income than average then about 15% to 20% should be paid.
Avoiding Capital Gains Tax
Let’s face it, you can’t help but pay taxes for certain properties as the law requires it but if you can avoid getting capital gains tax, then why not do it? Learning how to avoid it is the best and most legal thing that you can do if you really want to save your profits.
Avoiding capital gains tax is easy as you only need to live in the house for at least 2 years. Take note that it doesn’t have to be consecutive 2 years but it should sum up to 24 months. If you intend to sell your house within less than 2 years of residence, expect that gains can be taxable. So as I have said, live in it for a while and see how it goes before you decide on selling it.
Check and see whether you qualify or not. If you qualify as a good candidate to sell your house and be exempted for a capital gains tax. Don’t just assume that you are safe. Always be ready.
Lastly, keep all the receipts (or other documents you can gather) for all of the repairs you have done around the house. This could be a good basis for your capital gains tax exemption. Always remember that the higher your cost basis is, the lower capital gains tax should be.
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