When you sell your home, you will receive a large sum of money. Despite the fact that there are various expenses involved with a property sale, you can count on depositing a lump sum in the near future. Before you start planning how you’ll spend the money or shopping for a new property, you’ll want to know if you’re subject to the tax on capital gains. If this is the case, the profit from your house sale may be less than you anticipated. Let’s have a look at the capital gains tax when selling a house.
What Is a Capital Gains Tax?
A capital gains tax is a tax imposed on earnings gained from the sale of an asset. This tax arises in transactions involving a variety of assets, including real estate, bonds, equities, yachts, and automobiles. Homes usually rise in value in real estate, often resulting in the seller selling the house for much more than they paid for it. The difference between the two values is used to calculate the capital gains taxes on selling a rental house.
How to Avoid Capital Gains Tax On a Home Sale
- Repairs cost: The “cost basis” of your house in the context of tax on capital gains comprises the purchase price, some legal fees, remodeling expenditures, and other expenses. Including the cost of repairs and renovations to the home will raise the home’s cost base, lowering capital gains.
- Two-year window: You can claim the $250k or $500k exclusion if you haven’t claimed it on another property transaction in the previous two years.
- The 2-in-5 rule states that if you own a property and use it as your primary residence for two of the five years prior to the sale, you can exclude up to $250,000 in profits if you’re single, or $500,000 if married and file a joint return. If the profit exceeds these thresholds, the difference is recorded as a capital gain. The two years spent in the house shouldn’t have to be consecutive, nor do they have to be the final two years before the sale.
Gains On Capital Investments Subject to Tax
You must pay tax on capital gains if all or some of your profit from the sale of your home is taxable. The rates are much lower than your personal income tax rates if you have owned your home for over a year. If you didn’t own the house for more than a year, your capital gain is taxed at your personal regular income tax rate.
Capital gains on long-term investments are taxed at three distinct rates: 0%, 15%, and 20%. Your tax rate is determined by your tax filing position as well as your overall taxable income. As with most taxpayers, the tax rate on capital gains is 15%. However, if the income you get is too little, you will not be subject to tax on capital gains.
You pay no capital gain tax if your whole taxable income, comprising the capital gain subject to tax, lies between either 10% to 12% of your personal regular income tax categories. If the overall taxable income lies within the 22%, 24%, 32%, or 35% individual income tax categories, you must pay a 15% tax on capital gains. Long-term capital gains are taxed at a rate of 20% if your personal income puts you well above the upper 37% tax threshold.
Many people mistakenly believe that their profit is only based on the sale of their assets. The selling price of your home less deductible closing costs, your tax basis on the property, and selling charges equals your capital gain. (The initial purchase price and even purchase expenditures, plus the cost of capital upgrades, less accumulated depreciation, and any insurance payments or casualty losses, is your base). Prepaid interest or points on your mortgage, as well as your part of prorated property taxes, are all deductible closing costs.