When it comes to selling a home, there are a lot of different issues that have to be considered. One of those issues is taxes. These can be higher than expected for some home sellers, especially if they don’t understand how capital gains taxes work and how to legally avoid them.
But fortunately, there are ways to get around capital gains taxes in many cases, and to reduce the amount of tax that has to be paid in other cases. That way a home seller can save money when they sell their home, and reduce their tax burden considerably.
Here’s what any home seller needs to know when it comes to capital gains tax.
There’s a Time Requirement to Avoid These Taxes
If a home seller wants to avoid capital gains tax, they can do that by living in the home for two years out of the last five. The years don’t have to be consecutive, or the most recent ones. Just two out of the previous five will be enough. Then they can make up to $250,000 profit if they’re single or $500,000 profit if they’re married, and they won’t be asked to pay capital gains tax at all. If they make more profit than that, they’ll only need to pay tax on the difference between the amount their allowed and the amount they made, instead of the entire amount.
For example, if a single homeowner sells their house, and they have lived in it for two years out of the past five, they may make a profit. If that profit is $300,000, they’ll need to pay capital gains tax on $50,000, which is the difference between the $250,000 profit they’re allowed to make tax free and the $300,000 profit they actually received. The profit is based on the selling price of the house minus the purchase price plus any improvements that were made.
For many sellers, the requirements work out well and they don’t have to pay any capital gains tax at all when they sell their home.
Taxes Can Be Reduced for Sellers Who Meet Specific Criteria
For sellers who haven’t lived in their home for two out of the last five years, paying capital gains tax is a requirement at the time of sale of the property, in addition to any other closing-related costs. But there are ways to reduce the tax burden.
One of those is to make sure they hold onto the property for at least one year before they sell it. That way they will pay capital gains tax at the rate of 15 percent, instead of paying it at whatever their current tax rate is. For many people, their tax bracket is much higher than 15 percent so they can save thousands, or even tens of thousands, of dollars if they hold onto the property for at least a year.
After that point the property can be sold, because 15 percent is the lowest the taxes will go without meeting the two-year requirement for living in the property as a primary home. People who move frequently or who have investment properties or vacation homes may find that capital gains taxes become a bit burdensome, but they can always plan carefully for the one-year rule so they reduce their taxes as much as possible. The difference in the percentage of the profit they will owe can make a significant improvement on their tax burden.
When Selling an Investment Property, the Rules Are Different
It’s very important to consider that selling a primary home is different from selling an investment property or a vacation home. There is no way around capital gains tax for these types of properties. The only option is paying this tax at the 15 percent rate by keeping the property for a year.
Avoiding the tax isn’t possible, provided the seller makes a profit on the property. Since there isn’t a profit amount that can be made before capital gains taxes come into play, any profit will be taxable. Home sellers who plan ahead can ease their tax burden as much as possible, and can also focus on ways to prepare for the taxes they’ll be asked to pay when they sell a home that isn’t their primary residence.
Anthony Gilbert is the owner of The RealFX Group.
Anthony likes to write tips for home buyers and sellers and
believes knowledge is the best asset for anyone
involved in a real estate transaction.