Do Sellers Owe Capital Gains When They Sell Their Home?
Surprises can be great. Surprise tax bills aren't. When it comes time to sell a home, whether you're a first-time homebuyer or a seasoned real estate investor, it's good to know what you can expect from capital gains taxes. Capital gains taxes are imposed on earnings made from selling a home. While most home sales are tax-exempt, a few circumstances could result in a capital gains tax bill. Keep reading to learn about capitals gains taxes and discover how to estimate potential tax amounts.
No Taxes on First $250,000 of Primary Home
The good news is that, unless the home has appreciated significantly, most homeowners will not owe capital gains taxes. The first $250,000 in capital gains is exempt when selling a primary residence. It's important to note that capital gains are only owed on the net profit of a home. So, a house purchased for $150,000 and sold for $350,000 would have a $200,000 profit, which is under the ceiling for capital gains in most instances.
The $250,000 exemption is per individual. So, someone who is single or married and files separately would get a $250,000 exemption. Married couples filing jointly can exclude up to $500,000 in capital gains when they file their taxes.
What Does Primary Home Mean in This Context?
People who split their time between two homes may wonder whether their selling home qualifies as a primary home. The IRS determines primary residence through what is known as an ownership and use test.
The home must have been owned for at least two years before the sale to qualify for the capital gains exemption. And, to be considered a primary home, the owner must have resided there for at least two years out of the previous five.
So, imagine a couple buys a home for $200,000 and lives in it for one year. They then rent the house out to tenants for two years. In the fourth year, they move back in and reside there until year five. At the end of the fifth year, they sell for $500,000.
Since the couple lived in the house for three of the past five years, they'd be over the minimum for the exemption. And, as a married couple, their $300,000 profit would be within limits for the capital gains exemption.
The exemption can only be claimed every two years. Someone who owns two homes and sells one would need to wait for two years to claim the exemption again.
Can Captial Gains Taxes Be Reduced?
Often, homeowners can avoid paying capital gains taxes if they roll the proceeds from the sale into another home within 180 days of selling the first one. The new home would be considered a similar asset. Homeowners should consult with a tax or real estate attorney to determine when this sort of exemption can be taken.
Additionally, home improvement costs can be deducted when selling a home. This can include updated kitchens, bathroom remodeling, landscaping, painting the exterior, or replacing flooring. Homeowners should save all receipts and record when all work was done to apply this when tax time comes. Even when buying a new construction home, there are plenty of home improvement projects that can be exempt from capital gains taxes.
Are You Prepared for Capital Gains Taxes?
Selling a home for a significant profit is exciting. But, it's essential to ensure that you understand the tax rules going into a sale. Knowing what sort of taxes to expect after a sale and whether your sale is exempt can provide a great deal of peace of mind. Planning well can mean reducing what you owe, as well as being able to put funds aside should a capital gains tax bill come up due to the sale.