With real estate markets exploding across the country, more homeowners have significant home equity. Just 10 years ago, that was not the case.
In fact, many owners were selling at a loss due to the economic downturn from 2008-to 2012. It has been an unprecedented run in exploding home values since then.
Home sellers now need to be cognizant of capital gains tax on real estate when selling their property.
You may be paying a tax on the capital gains you make when you sell your house or invest in real estate. It’s called the capital gains tax, and it’s based on the amount of money you make from your purchase or investment.
Let’s consider what you need to know about real estate capital gains tax.
What are capital gains taxes?
A capital gains tax is a tax on the increase in the value of your investments over time.
When you sell a capital asset such as a home or other real estate, your gains become realized and are taxable income.
The profits on the sale of your home are not taxable until a sale occurs. The capital gains tax applies to profits on assets held for longer than one year.
Taxpayers may have to pay taxes on their long-term capital gains at a higher rate than they would if they had earned the money through work.
Taxpayers who earn their income through work may be taxed at a lower rate on their long-term capital gains, while those who earn their income from investments can be taxed at a higher rate.
The long-term capital gains tax rates are 0%, 15% or 20%, depending on your income.
Short term capital gains are taxed differently
Short-term capital gains are taxed as ordinary income. This means that the profit from selling assets that were held for less than a year is taxed at your regular income level.
You will pay ordinary income taxes at different rates depending on your tax bracket. For example, if you are in the 25% tax bracket, you will pay a rate of 25%.
Capital gains are reduced by the total amount of capital losses incurred in that year.
You have a capital loss when you sell an asset for less than the sales price.
The net capital gain is the total amount of your long-term capital gains minus any capital losses.
However, the sale of real estate is handled differently. One of the significant perks of homeownership is having a capital gains tax deduction. How your deduction is applied will depend on whether you’re single or married.
Real estate capital gains tax deductions explained
The deduction you receive when selling your principal residence is as follows:
- If you are single, you can make up to $250,000 in profits before paying any taxes on those earnings.
- If you are married, you can make up to $500,000 in profits before paying any capital gains taxes.
Understanding how to reduce your taxes further when selling a house should be paramount.
What are the requirements for taking a real estate capital gains deduction?
The following must be true to qualify for capital gains deduction on real estate sales.
- The property needs to be your principal residence. The tax break is for those who are selling their primary residence. It is not available for people selling an investment property or a rental.
- You must have lived in the home for two out of the last five years. Timing when selling becomes crucial.
- Know your spouse’s history on claiming the deduction. If your new spouse has used the exclusion within the last two years—like selling their home to move in with you—it will impact the ability to use it for the current house sale.
You report capital gains after the closing
The IRS considers a home sale to be an event that triggers taxable income. This means that, depending on the circumstances of your sale, you may owe taxes on any money you receive from the sale.
During the closing, the closing agent or bank attorney will have you sign a tax form called the 1099-s. The document asks whether the sale is a taxable event or not.
Signing the form ensures the IRS knows whether you owe them money or not. It’s not something you would want to lie about as it could easily trigger an audit.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell MetroWest Massachusetts real estate for the past 35 years. Bill is the owner and founder of Maximum Real Estate Exposure. For the past decade, he has been one of the top RE/MAX REALTORS® in New England.
