Capital gains tax on real estate and selling your home

Selling your home can be a lucrative endeavor, but it’s important to be aware of the potential impact of capital gains tax on your profits. This tax is applicable to the profit you make from selling an investment or asset, including real estate. Fortunately, there are strategies available to help you minimize or even avoid capital gains tax on your home sale. In this article, we’ll explore these strategies and provide valuable insights to help you keep more of your hard-earned money.

Understanding Capital Gains Tax:

Capital gains tax is a levy imposed by the IRS on the profit made from the sale of an asset, such as real estate. It is calculated by subtracting the asset’s original cost (tax basis), along with any incurred expenses, from the final sale price. Long-term capital gains tax rates vary depending on your income and range from 0% to 28% for certain special asset types.

Capital Gains Tax on Real Estate:

For properties owned for less than a year, short-term capital gains are taxed as ordinary income, which could be as high as 37%. Properties held for over a year qualify for long-term capital gains tax rates of 0%, 15%, or 20%, depending on your income tax bracket.

Factors affecting the tax rate include your income tax bracket, marital status, ownership duration, and property type (primary residence, secondary residence, or investment property). It’s crucial to accurately calculate the profit and report it to the IRS when filing your tax return.

Strategies to Reduce Capital Gains Tax:

1. Primary Residence Exemption:
   • If your property was your primary residence for at least two of the five years preceding the sale, you can exempt up to $250,000 (or $500,000 if married and filing jointly) in profit from capital gains taxes.
2. Rental Property Considerations:
   • Rental properties do not have the same exclusions as primary residences. Be aware of the 25% depreciation recapture tax on previously claimed depreciation, along with long-term capital gains taxes.
3. Establishing Rental as Primary Residence:
   • Moving into an investment property you plan to sell for at least two years can convert it into a primary residence, potentially avoiding capital gains tax. However, be mindful of the depreciation portion.
4. 1031 Exchange:
   • Utilize a 1031 exchange, also known as a like-kind exchange, to defer capital gains tax by reinvesting the sale proceeds into a similar property.
5. Opportunity Zones:
   • Investing in designated low-income communities can provide tax advantages, including a step-up in tax basis after five years and tax-free gains after ten years.
6. Deducting Expenses:
   • Lower your taxable profit by deducting qualifying expenses such as repairs, improvements, losses from tenant non-payment, and associated closing costs.

Conclusion:

Selling your home is a significant financial transaction, and understanding how to navigate capital gains tax can significantly impact your bottom line. By employing these strategies and seeking advice from a tax advisor, you can maximize your profits and keep more of your hard-earned money from the sale of your property.