An Understanding of Capital Gains Tax and Selling Your Home
When you are in the process of selling your home, it is understandable that you want to make a nice profit. However, it is important to be wary of a decrease in your earnings when tax day rolls around, aka the federal capital gains tax. If your home has seen an increase in value, you might be liable for a substantial sum when paying your annual income tax. There are, however, ways that you can avoid or cut down on the capital gains tax on a home sale to keep as much profit in your pocket.
In this article, we will divulge how you can handle capital gains tax when selling your home.
What is Capital Gains Tax in Real Estate?
Capital gains tax is the tax owed on the profit made when selling an investment or asset, particularly your home. This can be calculated by subtracting the asset’s initial cost or purchase price plus expenses incurred from the final sales price. Special rates can be applied for long-term capital gains on assets owned for longer than a year. The long-term capital gains tax rates are usually 15%, 20%, and 28%, depending on your income. There is a direct tie to your capital gains tax and the property’s value and increases in the value. If your home appreciated after you bought it, and you realized the appreciation when it was sold, you might have a sizeable taxable gain.
How Much is Capital Gains Tax on a Primary Residence?
Calculating capital gains tax in real estate can be a complex process. The tax rate will depend on a few factors, including the following:
- The income tax bracket.
- Martial status.
- How long you owned the house for.
- If the house is the primary, secondary, or investment residence.
How Can I Avoid Capital Gains Tax on a Home Sale
Capital gains taxes can affect you, bottom line. Fortunately, there are plenty of great ways that you can reduce them on your home sale or completely avoid them altogether. Depending on the type of property and your filing status, the IRS offers different scenarios to avoid capital gains taxes when selling your house.
If the Home Is Your Primary Residence
You can sell your primary residence and avoid paying capital gains taxes on the first couple hundred thousand of your profits if your tax-filing is single, and up to $500k if married or filing jointly. This exemption is only available once every two years. To qualify as a primary residence, the IRS will require you to prove the property was your main residence where you lived most of the time. You will need to show that you owned the home for a minimum of two years. There is wiggle room in how the rules are interpreted. For example, you do not have to show that you lived in the home the entire time that you owned it or even for two years. As long as you have been living in the property as your primary residence for 24 months within the five years before the home’s sale, you can qualify for a capital gains tax exemption. If you are married or considering filing jointly, only a single spouse has to meet this specific requirement.
1031 Exchange
You can easily take advantage of a 1031 exchange. Also known as a like-kind exchange, it works if you sell the investment property and use the proceeds to purchase a similar property. If you continue putting the sale proceeds into another investment property, you can put off capital gains tax.
Opportunity Zones
Opportunity zones are areas around the country that are identified as economically disadvantaged. If you opt to invest in a low-income community, you will be set up on a tax basis after the first five years, and gains after 10 years will be officially tax-free.
Deduct Expenses
If you have capital gains after taking advantage of exclusions and exemptions, focus on lowering the amount of taxable profit or gains. Remember to keep organized documentation and records, including bills, receipts, credit card statements, and invoices, to support your expense claims for the instance you are audited. Qualifying deductions include:
- Cost of repairs made to the home.
- Upgrades and improvements made to the home.
- Closing costs from a property sale.
Conclusion
Capital gains taxes can be substantial, particularly when providing relief to homeowners who meet IRS criteria. There are always exceptions for criteria situations, and having a general understanding of the tax rules and staying ahead of tax changes can help you better prepare for the sale of your home. If you are in the market for a new home, compare all the best mortgage rates before applying for a loan. Work closely with a trusted real estate professional for smooth sailing during all the steps to selling or buying a new home. Trust the real estate professionals at Palm Beach Coastal Realty to guide you in finding and settling down in the home of your dreams in the many beautiful luxury neighborhoods that make up Palm Beach Gardens, FL, today.