Do You Have to Pay Capital Gains Tax on Real Estate?
- When selling a home, capital gains are subject to taxes. However, certain exemptions can mean most people pay little or no tax. Learn about these and other ways you may be able to lower or avoid capital gains taxes.
For many if not most people, their most valuable asset is their home. Like all assets, a house (and other real estate) is subject to a special tax when it’s sold. This is called a capital gains tax.
This tax is applied the amount your home appreciated in value since its purchase. However, legislation known as the Taxpayer Relief Act of 1997 gives most homeowners an exemption for a large amount of their home’s value.
What Is a Capital Gains Tax?
A capital gain is the difference between what you pay to purchase an asset – known as the basis – and what you sell it for later. Capital gains can be made with all investments, including stocks, bonds, vehicles, boats and real estate.
The Internal Revenue Service and some states assess a tax on the capital gain when it is sold. Short-term capital gains are taxed as ordinary income, with rates up to 37% for high-income earners. Long-term capital gains tax rates are 0%, 15%, or 20%, depending on the individual’s income and tax filing status.
- Short-term capital gains tax rates typically apply to an asset that is owned for less than one year. The rate is equal to your ordinary income tax rate, also known as your tax bracket.
- Long-term capital gains tax rates typically apply to an asset owned for more than one year. Many people qualify for a 0% tax rate. Everybody else pays either 15% or 20%. It depends on your filing status and income.
What Are the 2021 Maximum Capital Gains Rates?
Your maximum level of capital gains tax (the maximum rate) depends on whether you file your income taxes as a single adult, as married or as head of household, as well as your level of taxable income. The chart below outlines the capital gains tax rates in 2021 based on filing status and income.
|Filing Status||0% Tax Rate If Your Income Is||15% Tax Rate If Your Income Is||20% Tax Rate If Your Income Is|
|Single||< $40,000||$40,000 to $441,450||< $441,450|
|Married filing jointly||< $80,000||$80,000 to $496,600||< $496,600|
|Married filing separately||< $40,000||$40,000 to $248,300||< $248,300|
|Head of household||< $53,600||$53,6000 to $469,050||< $469,050|
The IRS allows homeowners to exclude up to:
- $250,000 of capital gains on real estate if they are single
- $500,000 of capital gains on real estate if they are married and filing jointly
For example, if you bought a home for $250,000 in 2011 and sold it for $800,000 in 2021, your capital gain is $550,000. If you’re married and filing jointly, $500,000 of that gain may be exempt from the capital gains tax, but $50,000 of the gain might be taxable.
To be eligible for the $250,000 or $500,000 exemptions:
- The house must be your principal residence.
- You must own the property for at least two years in the five-year period before you sold it.
- You must live in the house for at least two years in the five-year period before you sold it. (Exceptions to this include those who are divorced, disabled, military personnel, Foreign Service or intelligence community members.)
- You have not already claimed the $250,000 or $500,000 exclusion on another home in the two-year period before this sale.
- You did not come to own the house through a like-kind exchange (known as a 1031 exchange) in the past five years.
- You are not subject to expatriate tax.
You can only benefit from this exemption once every two years. if you have two or more homes and lived in each of them for at least two of the last five years, you are not allowed to claim the exemption on more than one in a two-year period.
Therefore, it would be to your tax advantage to sell one property first and converting a second property to your principal residence for at least two years before selling it as well.
How to Avoid Capital Gains Tax
There are strategies in place that can help homeowners reduce or avoid capital gains taxes:
- Live in the house for at least two years.
- Check for other exceptions. The IRS may exclude some taxable gains if the house was sold because of work, health or “an unforeseeable event.”
- Keep all home improvement receipts.
The cost basis of your home increases when you make certain allowable capital improvements. A higher cost basis decreases the capital gain and, thus, the tax. Allowable improvement include, but are not limited to:
- New windows
- New driveways
- Air conditioning installs
You must provide the receipts of all improvements at the sale to recalculate your cost basis.
Apply other capital losses. Losses from other investments can sometimes be used to offset the capital gains from a home sale.
Talk to a Professional
It's always a good idea to talk to a tax professional before selling a property. He or she will advise you on any changes in the tax code and other considerations for selling your home.