Capital Gains in Real Estate: Will You Owe Money from Your Home Sale?

Selling a home is a huge endeavor. There are upgrades and repairs to make, a real estate agent to find, and then all of the paperwork once a buyer is found. Home sellers who want to make sure they've remembered everything should also check whether their home sale will trigger a capital gains tax bill. The good news is that many sellers are unlikely to owe capital gains tax. There are, however, a few situations that can mean putting aside some home sale profits to cover the tax bill before putting money towards your next down payment or mortgage.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.

Will Someone Selling a Second Home Owe Capital Gains?

If someone sells a vacation, second, or investment home, there is a good chance they will owe capital gains tax on the sale. Primary homes can qualify for an exclusion, but it's less likely to be the case for selling secondary homes.

However, just because a home has been used as a rental or vacation home, there is still a chance to get an exemption from capital gains tax. These homes can be converted to primary homes if they are occupied for two years out of the last five. If someone buys a home, lives in it for one year, uses it as a vacation home for three, and then lives in it again the last year, it will be considered a primary home. The years occupied do not have to be consecutive, which makes this more convenient. The duration of ownership also affects whether a short-term or long-term capital gains tax rate applies.

When Are There Capital Gains Taxes on a Primary Home?

Primary homes are typically excluded from capital gains taxes, except in a few circumstances. If the home has dramatically appreciated, there is a chance it will trigger capital gains. Only the first $250,000 ($500,000 for couples who file jointly) is exempt from capital gains tax. Sellers will be relieved to know that only their profit is subject to capital gains tax. That means if a home is purchased for $300,000 but sells for $500,000, the profit—$200,000—falls below the exclusion level.

One other situation could mean that a seller owes capital gains tax: the capital gains exemption can only be taken once every two years. If someone sells a home and claims the exemption, then buys and sells another property within the next two years, they'll have to pay capital gains taxes.

How to Reduce Capital Gains Tax

If a seller does wind up owing capital gains tax, they can do a few things to lower the bill.

First, they can examine any receipts associated with the home. The costs of home improvements like bathroom remodeling, kitchen repairs, new carpet, and other costs are often deductible. These upgrades may be more common in homes used for rental income.

Capital gains taxes can also be avoided by rolling any profits into a new asset within 180 days of the sale. The investment has to be considered one of a similar asset class. People should talk to a tax attorney about what kinds of purchases qualify. The rules can be complex and hard to follow, so it's essential to make sure the new purchase falls under the covered types.

Many home sellers will not encounter capital gains taxes on the sale of their homes. However, it's still a good idea to learn about the potential tax implications to avoid surprises later on. Reading up on who owes taxes when and how this might apply to a specific sale can help sellers prepare. Knowing the ins and outs of taxes can help sellers plan better and hopefully keep more profit.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.