✏️ Editor’s Note: Realtor Associations, agents, and MLS’ have started implementing changes related to the NAR’s $418 million settlement. While home-sellers will likely save thousands in commission, compliance and litigation risks have significantly increased for sellers throughout the nation. Learn how NAR’s settlement affects home sellers.
Capital gains tax is a levy imposed on the profit generated from the sale of a capital asset. To calculate it, you deduct the original price and the cost of any improvements made to the property from the sale price.
Capital gains tax can be categorized into Short Term Capital Gains Tax (STCG) and Long Term Capital Gains Tax (LTCG). STCG tax applies to profits from selling assets held for a year or less. Conversely, properties owned for over a year incur LTCG tax.
Why does capital gains tax exist, you ask? The answer is quite simple. The IRS imposes this tax to generate revenue for the government. The funds raised from this tax play a crucial role in supporting various government programs and expenditures.
Capital Gains Tax Implications
- Taxable Property: Capital gains tax is triggered when you sell a real estate investment, leading to a profit or gain.
- 1031 Exchange: Investors can defer capital gains taxes by utilizing a 1031 exchange, reinvesting sale proceeds into a similar property.
- Depreciation Recapture: If you claim depreciation on the property, some of the profit gets taxed at a different rate.
- Net Investment Income Tax (NIIT): High-income earners may be subject to an additional 3.8% NIIT on net investment income, including real estate gains.
Types of Capital Gains Tax on Real Estate
» Jump to: Short-Term Capital Gains Tax | Long-Term Capital Gains Tax
The amount of tax you pay depends on several factors, such as:
- Homeownership Duration
- Property Purchase Price
- Home Sale Price
Short-Term Capital Gains Tax Rates
STCG tax rates for 2023 range from 10% to 37% based on your income level. Taxpayers with lower incomes typically pay a 10% tax rate on short-term gains. However, higher-income individuals are subject to the maximum rate of 37%.
| Tax Rate | Single Individual | Head of Household |
|---|---|---|
| 10% | $0 to $11,000 | $0 to $15,700 |
| 12% | $11,001 to $44,725 | $15,701 to $59,850 |
| 22% | $44,726 to $95,375 | $59,851 to $95,350 |
| 24% | $95,376 to $182,100 | $95,351 to $182,100 |
| 32% | $182,101 to $231,250 | $182,101 to $231,250 |
| 35% | $231,251 to $578,125 | $231,251 to $578,100 |
| 37% | $578,126 or more | $578,101 or more |
Long-Term Capital Gains Tax Rates
LTCG tax rates for 2023 range from 0% to 20%, depending on your taxable income and filing status.
| Filing Status | 0% Rate | 15% Rate | 20% Rate |
|---|---|---|---|
| Single | Up to $44,625 | $44,626 – $492,300 | Over $492,300 |
| Married Filing Jointly | Up to $89,250 | $89,251 – $553,850 | Over $553,850 |
| Married Filing Separately | Up to $44,625 | $44,626 – $276,900 | Over $276,900 |
| Head of Household | Up to $59,750 | $59,751 – $523,050 | Over $523,050 |
Capital gains rates remained unchanged with the implementation of the Tax Cuts and Jobs Act in 2017. However, the income thresholds for each bracket are adjusted annually to reflect the rising incomes of working individuals.
How Does Capital Gains Tax on Real Estate Work?
Here’s how you file capital gains tax on home sales:
- Calculate the Gain: To calculate the capital gains tax, you need to subtract the original price of the property from the selling price of the property.
- Identify the Holding Period: The duration of ownership influences tax rates. Therefore determine whether your property falls under STCG or LTCG.
- Apply Tax Rates: Apply the STCG tax or LTCG tax based on the holding period. STCG taxes are taxed at regular income rates (up to 37%). Whereas LTCG tax has lower rates (0%, 15%, or 20%), depending on the income.
- Deduct Expenses: You can lower your taxable gain by deducting sale-related expenses like agent fees, legal fees, and improvement costs.
- Look for Exemptions: You might qualify for exemptions like the U.S. primary residence exemption, which lets you exclude some gains from taxation.
- Pay the Tax: Finally, you pay the capital gains tax when you file your income tax return.
When Do I Pay Capital Gains Tax?
You report and pay capital gains tax when you file your income tax return for the year. For example, if you sell a property in 2023, you would report and pay the tax in your 2023 tax return, filed in 2024.
Generally, individual tax returns are filed by April 15th of the following year. You have to make estimated tax payments during the year based on where you live and your capital gains.
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⏰ Reminder: Explore any exceptions or deferrals available in your jurisdiction. Some regions provide opportunities to defer capital gains tax if you reinvest the proceeds within a specified timeframe.
Capital Gains Exemptions
The IRS provides several exemptions that can reduce or eliminate capital gains tax liability for certain taxpayers.
- Singles: Unmarried individuals can exclude the first $250,000 of their home sale profit from taxation. You can use this exemption once every 2 years.
- Married Couples: Couples filing a joint return are exempt from paying $500,000 from the earned net proceeds.
- Divorcees: Divorced couple can claim a $250,000 exemption. For that, you have to own and live in your primary residence for at least 2 years.
- Widowers: Widowers needs to have owned and lived in the home for at least two out of the five years before selling it. Also, the sale must happen within two years of the spouse’s death to get this tax benefit.
- Military Personnel: Military personnel are eligible for certain tax breaks, reducing their liability for capital gains tax. Similarly, disability compensation and survivor benefits are usually exempt from taxes, including capital gains tax.
- Government Officials: Some officials may qualify for capital gains tax breaks if they are directly related to their work, like relocation expenses.
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📢 Remember: Divorce and inherited property sales are complicated. They can also have many tax consequences. Homeowners should talk to a tax expert for all possible tax benefits.
How to Avoid Capital Gains Tax on Real Estate?
Here are some ways to avoid capital gains tax on real estate in the US:
- Occupy the House for at Least 2 Years: Live in a home for two years before selling to qualify for a capital gains exclusion. Individuals can save up to $250,000, and $500,000 for married couples.
- Qualify for an Exception: Exceptions may apply if you sell your home due to a change in employment, health issues, or unforeseen circumstances.
- Keep Receipts for Home Improvements: Keeping track of home upgrades helps lower your capital gains tax. You can add the cost of home improvements to your home’s basis.
- Reinvest Sale Proceeds: As per the 1031 exchange, you can reinvest the amount from the sale into another property. By doing so, you can postpone paying capital gains tax.
- Offset Capital Gains with Losses: You can counterbalance capital gains with losses from other investments. If you experience an overall loss, you can deduct up to $3,000 from your taxable income annually.
- Deduct Expenses: You can deduct expenses when selling your home, including real estate agent commission and closing costs.
- Establish Rental as Primary Residence: If you designate a rental property as your primary residence before selling it, you may qualify for a capital gains exclusion of up to $250,000 (or $500,000 if you’re married).
Conclusion
Capital gains tax rates depend on taxable income. You can calculate it by subtracting the origional price from the selling price of the property.
Failure to pay capital gains tax on real estate can lead to penalties and interest charges as per tax laws. Legal action, including asset seizure, may be taken to recover outstanding amounts. Follow tax rules, pay on time to avoid problems and stay financially secure.
FAQs
What is the capital gains tax rate on real estate?
A capital gains tax on real estate applies to profits from home or residential property sales. Meeting specific ownership and usage criteria can allow for an exemption of up to $500,000. Read more about capital gains on real estate's working.
Do I have to pay the capital gains tax if I sell a second home or rental property?
Yes, if you sell a second home or rental property in the US, you pay capital gains tax on the profit made from the sale.
» Avoid Capital Gains Tax on Real Estate: Avoiding capital gains tax entirely is challenging, but there are legal strategies to minimize or defer the tax burden. Read to know more.
What is the 2 in 5 Year Rule?
The 2-Out-of-5-Year Rule is a tax law that lets homeowners avoid paying capital gains taxes when they sell their main home. If you're a single filer, you can exclude the first $250,000 from taxation, and if you file jointly, you can exclude up to $500,000. Learn more about the capital gains exemptions.
Is there an over-55 home sale exemption?
Yes, the over-55 home sale exemption was a tax law allowing homeowners over 55 to exclude some capital gains when selling their residences. However, this law was replaced in 1997 with the Taxpayer Relief Act.
