You've sold your home and even made a profit! But depending on how much you made from the sale, you may have to pay capital gains tax.
What is a Capital Gains Tax?
When you sell an asset like stocks, cars, or real estate, the profit you make can be considered taxable income. If you earn a big enough profit, you’ll be required to pay tax on it.
Whether you’ve made improvements to your home and/or the value has increased with the market, you’ll need to be prepared for a potential tax obligation. Here are some guidelines and strategies to help you reduce or avoid your capital gains tax.
Capital Gains Tax Exclusions
You can avoid paying any capital gains tax on the first $250,000 if you’re single and on the first $500,000 if you’re married. So if your profit is less than that, you do not own any taxes on your capital gain!
There are a few other requirements in order to qualify for the tax exemption:
● You can only claim this exemption once every two years.
● The home must be your principal residence.
● You must have owned and lived in your home for at least two out of the last five years.
How do you calculate your capital gains? It’s not just subtracting your original purchase price from your sale price. There are more costs you can deduct to arrive at the right calculation. Instead of just the purchase price, you subtract your cost basis from the sale price to determine your capital gains. The cost basis is the purchase price plus eligible expenses that were incurred when you purchased your home plus the cost of any home improvements or additions.
cost basis = purchase price + eligible expenses + cost of improvements/additions
Other Ways to Avoid or Reduce Capital Gains Tax
If you don’t qualify for the exclusion, there may still be ways to avoid the tax or at least reduce it.
If you haven’t lived in your home for two years, you may be able to get a partial exclusion. If you moved because of a job transfer, health reasons, or an unforeseeable event, like death or divorce, you can exclude a percentage of the maximum amount based on the amount of time you lived in the home. For instance, if you lived there for 12 months, you can exclude half the maximum amount or $125,000 for a single person. So if your profit was $125,000 or less, you won’t have to pay any capital gains tax.
Another way to minimize your capital gains is to maximize your cost basis. Make sure you keep receipts for any home improvement projects. Remodeling, putting on an addition, new windows, and more can count toward the total cost, or cost basis, of your house.
A 1031 exchange can also help you avoid capital gains tax. If you own an investment property and want to sell it in order to buy a new one, a 1031 exchange allows you to reinvest the proceeds and defer capital gains tax.
If you are expecting a gain larger than $250,000 (or $500,000 for a married couple), consider whether you can divide ownership of the house. For instance, if there is another adult living in the house that meets the eligibility requirements, you can each claim a share of the house, and that person can qualify for a $250,000 exemption on their share too.
Fortunately, most homeowners are exempt from capital gains taxes. If you’re ready to sell, connect with me today so we can see how much profit you can make (and do our best to help you avoid that capital gains tax altogether).