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Profits from a home sale are subject to capital gains taxes. This sale will count toward your total capital gains for the year, and will be taxed at the normal rates of either 0%, 15% or 20%.
That said, when it comes to home sales, the IRS allows you to exempt a portion of the profits from your taxes. Specifically, if you sell your primary residence you can exempt up to $250,000/$500,000 (single/married) from your taxes over your lifetime.
For example, say that you sell your house for a profit of $435,000. As an individual, you will likely owe taxes on $185,000 of these gains if you haven’t used this exemption previously. Here’s what you should know. You can also match with a financial advisor who can help you apply the rules to your own situation.
When you sell real estate, any profits that you make are taxed as capital gains.
Profits in this case are defined as your sale price, reduced by the property’s tax basis. A property’s tax basis is based on several factors, but overall it’s the total amount of money you spent to purchase, upgrade and sell the property. This can include, but is not limited to:
Original sale price
Additions, modifications and updates
Staging, fees and related costs of the sale
Depreciation or lost value
Crucially, this does not include maintenance and upkeep. For example, replacing your washing machine once it stops working properly would not count as an upgrade. Your cost basis is increased by any money that adds to the property’s overall value, such as a bathroom renovation or room addition. This is called “qualified spending.” So, for any given piece of real estate, your profits (or “taxable gains”) are calculated as:
For example, say that you spend $450,000 to buy a house. You then spend $15,000 updating and expanding the kitchen. At this point your cost basis for the house is $465,000. If you sell the house for $500,000, your profits will be $35,000 ($500,000 – $465,000).
Any profits from selling real estate, including a home, will be taxed as capital gains. This means that they will be subject to a lower tax rate separate from income taxes, although your capital gains rate is determined by your total taxable income. For most households, the capital gains rates are:
0%: Up to $47,025 single / Up to $94,050 joint
15%: $47,025 – $518,900 single / $94,050 – $583,750 joint
20%: $518,900+ single / $583,750+ joint
So, in our example above you might have $35,000 in profits from selling your home. As either an individual or a married couple you would fall within the 0% tax bracket, assuming you have no other income. This is as opposed to if you earned $35,000 from working a job, in which case you would fall within the 15% tax bracket for capital gains.
Consider speaking with a financial advisor for capital gains tax strategies and more.
When you sell your home, the IRS allows you a limited lifetime exemption on applicable capital gains taxes. An exemption is an amount of money that you deduct from profits or income before calculating your taxes. This, in turn, reduces your overall taxes by lowering the money subject to taxation. This exclusion is known as the Home Sale Exemption or a Section 121 Exclusion.
The home sale exemption applies when you sell your primary residence. It allows you to exempt up to $250,000 for individuals or up to $500,000 for married couples filing jointly. This exemption applies to the profits from your home sale, not the price. This exemption is not refundable, meaning you cannot reduce your tax burden below $0.
So, in our example above, say you sell your home and receive $35,000 in profits after cost basis. You would then exempt the first $250,000/$500,000 of those profits, reporting only the remainder on your taxes. This would reduce your taxable profits to $0. And next time you sell a home, you may be able to exempt yourself from up to $215,000 remaining profits as a single filer.
There are a few requirements for a sale to meet the home sale exemption. Collectively, these requirements are known as the “ownership and use test.” They are:
The property must be your primary residence
This must have been your primary residence for at least 2 of the past 5 years
You must own the property
The primary residence rule means that you cannot apply this exemption, say, to selling a rental property, second home, vacation home or similar property. You can only have one primary residence at a time, but the residence period can be nonconsecutive. That is, the property could have been your primary residence for 12 months, then you can move, then you can have it as your primary residence again for 12 months.
The purpose of the ownership and use test is to ensure that you are not flipping a property, and to prevent individuals from claiming residency in a vacation home for a brief period in order to claim the exemption.
The Section 121 Exclusion entirely replaced like-kind exchanges for home sales. You cannot take a like-kind exchange when selling your home or any property for personal use, and have not been able to do so since the late 1990s. You can match with a financial advisor if you have questions about this rule.
Here, will you pay capital gains taxes?
Let’s say you’re an individual who has just sold their house for a net profit of $435,000. This means that after accounting for cost basis (purchase price and qualified spending) you still have $435,000. Will you pay capital gains taxes?
The answer is, in almost all cases, yes.
If we assume that this is your primary residence and that it meets the use and occupancy tests, as an individual you will have an exemption on this sale worth $250,000. This will reduce your taxable profits to $185,000. If you have no other taxable capital gains this year, this would put you in the 15% tax bracket and generate a capital gains tax bill of about $20,696.
You cannot defer this tax bill by purchasing a new home or cycle it into a like-kind exchange. Both of these approaches are allowed for investment and commercial real estate, but they do not apply to residential property. Taxes can be complicated depending on your personal circumstances. Consider speaking with a financial advisor who can help you build an appropriate strategy.
When you sell real estate, any profits are subject to capital gains taxes. However when you sell your primary residence, you can exempt up to the first claim a tax exemption that will offset between $250,000 and $500,000 of your profits.
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