So you’re selling your home! What an exciting yet nerve-wracking time. Let’s get down to it: the bad news is that the money you make from this transaction is taxable. But the really good news is that there are ways to avoid capital gains tax on home sale by minimizing or eliminating it completely. It’s time for us to give you a little insight on exactly how that can be done.
What Is Capital Gains Tax?
First off, what is capital gains tax? A capital gains tax is a tax on capital gains, or the profit realized on the sale of a specific type of asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, and in this case, property.
As a rough example, let’s say you bought a home in 2012 for $200,000 (this number is your basis). You sold it for $295,000 in 2018, meaning your gain on the sale was $95,000. This is the amount that will be taxed, which is why selling your home for a bigger price isn’t as ideal when you think of it from a tax perspective: more gain = a higher percentage you’re paying to the government. One of the first things you can do as far as minimizing gains tax is looking into the current real estate market and making sure that the time you’re choosing to sell is ideal as far as price points go.
Two Types of Capital Gains
The money you make from selling a home is dependent on two things: whether you yourself lived in the home (is it your primary property?), and if so, how long you’ve lived there. The first form of capital gains is short term, meaning you’ve held a property for less than 12 months and will probably pay higher taxes (short term capital gains are taxed at the same rate as normal income). There are also long term capital gains, meaning you held the property longer than 12 months and will likely benefit from a reduced tax rate, not exceeding 20%. The average rate for short term capital gains tax falls anywhere from 10-39.6%, with most people paying around 25%. It largely benefits you as a seller to have lived or owned the property for a longer amount of time in terms of lowering capital gains tax.
How To Avoid Capital Gains Tax
If you’ve held your property for a longer amount of time, the tax code also provides a huge tax break when it comes to selling a personal home. According to the IRS Publication 523, “the tax code recognizes the importance of homeownership by providing certain tax breaks when you sell your home”. These breaks come in the form of $250,000 of gain for single individuals and $500,000 for those who are filing as married.
The requirements for this tax break are:
- You’ve owned the home for at least two years.
- You’ve lived in the home for at least two of the five years prior to selling.
- Your home was your primary residence for at least two of the five years prior to the selling period.
- You haven’t exempted the gains on another home sale in the last two years (this goes for both you and your spouse if jointly filing).
Because this exclusion is so large, it can be enough to cover all capital gains tax for most married couples who decide to sell their home (and meet the above stipulations).
Another way to avoid capital gains tax is to keep track of your renovations and home improvements. Surprisingly enough, things like replacing your hardwood floors, fixing your roof, or remodeling your kitchen can be added to your property’s basis (the initial price for which you purchased your home/the price your home is valued at). An improvement, according to the IRS, is anything that betters your home, adapts it, or restores it to a previous condition. This includes upgrading windows, fixing plumbing, adding insulation, heating, or cooling, as well as restoring damaged appliances. Remember to keep copies of receipts and records of every purchase you’ve made as proof may be required down the line.
In addition, you can also keep track of selling expenses. The sale price of a home can be reduced by any costs associated with the actual selling of the home: subtracting these expenses from the final sale proceeds have the power to significantly reduce your capital gain tax numbers. As noted by MoneyCrashers, you can’t deduct maintenance expenses from your reported selling price. But there are many selling costs that qualify for exemption such as settlement fees, broker commissions, escrow and closing costs, advertising and appraisal fees, points paid by the seller, title search fees, and transfer taxes.
Now, how about we take something new into consideration: let’s say you have some capital gains that don’t fall under the exclusions listed above. Even if you haven’t lived in your home for two of the last five years, you can still be eligible for a partial exclusion of capital gains if you sold “…because of a change in your employment, or because your doctor recommended the move for your health, or if you’re selling it during a divorce or due to other unforeseen circumstances such as a death in the family or multiple births” (Nolo.com). In cases like these, you’d have to calculate what the portion of your exclusion would be based on the amount of time you lived in said home.
A few important things to remember:
- Capital gains tax only applies to assets such as stocks, bonds, jewelry, coin collections and real estate property.
- Capital gains tax is only paid after the asset at hand is sold.
- Taxpayers can use legal strategies to offset capital gains with capital losses in order to lower their capital gains taxes.
If you’re meeting the requirements for capital gains tax exemption, enjoy the benefits! If you’re not ready to sell your home just yet, now you have the knowledge you need to properly approach the situation when the time comes. You always have the option of working with an experienced real estate agent or trusted tax advisor to avoid any unnecessary deductions. Make the most out of selling your home!
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