How to Determine Capital Gains When Selling a Home

What to Know About Capital Gains and Your Home SaleFirst-time home sellers should know about capital gains before they're applied to the final sale price of the home. The following information can give sellers a better understanding of this concept and help them keep their profits.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.

What Are Capital Gains?

Capital gains are a way for the government to tax profits. If a person purchased an asset (be it a stock, property, or consumer item) and it increases in value, the profits are added onto the investor's income and then taxed at a progressive rate. For example, if a homeowner bought a home at $300,000 and sold it three years later at $400,000, their profit would be $100,000 (less certain expenses, which will be covered below). In effect, this would be the same as the owner getting a $100,000 raise that year.

The Exceptions to Capital Gains

There are some exceptions to the capital gains rule. The government has made it possible to deduct up to $250,000 worth of capital gains per owner for home sales, as long as the owner held the property for at least five years and lived in it for at least two years.

Those who want to rent their property can still do so as long as they make that home their primary residence for 24 months (however, these months do not have to be consecutive). In the case of a married couple who both own the home, the deduction would be up to a half-million dollars.

Can Sellers Deduct Other Expenses?

Sellers can deduct a number of expenses from their home sale:

  • Current sale expenses: This can include closing costs, real estate commission, staging fees, and professional photography.
  • Renovation costs: Major renovations to the property during the time of ownership can be included in the deduction costs.
  • Original sale expenses: Homeowners can apply costs related to the original sale of the property.

These expenses function to lower the costs of the final sale, which in turn reduces the profits between the original price that the home was purchased for and the final price it sells for. Owners should have receipts for all expenses in case they're challenged and should speak to a qualified professional to understand more about which expenses may and may not apply.

How to Calculate Capital Gains

Once homeowners have calculated their final sale price, they can use the following progressive scale to determine how much they'll pay in capital gains. (These numbers are for single filers only.)

  • Sellers who make between $39,375 and $434,550 per year will pay 15% in capital gains tax.
  • Sellers who make above $434,550 per year will be taxed at 20%.

If a seller makes $35,000 a year and sells their home for a $20,000 profit, they would be taxed at a 15% rate on $20,000 because their income would officially move above the threshold for that year.

Depreciation and Capital Gains

Homeowners who rent out their homes are liable to claim depreciation when they're filling out their annual income statements. The more depreciation they claim, the less they'll have to pay in taxes when renting it out. However, depreciation will also be factored into capital gains during the time of the sale, which can be devastating for properties that have significantly increased the value. Homeowners who know that their property is located in a popular area should consider how depreciation will affect gains before estimating depreciation.

Is It Possible to Avoid Paying Capital Gains?

Some homeowners may not be eligible for the $250,000 per owner exemption, especially if they need to unexpectedly sell their home soon after they purchased it. If so, it is possible to offset capital gains through capital losses. If homeowners sold an asset for less than what they purchased it for, they can deduct those losses from their gains.

There is also the possibility of deferring the taxes through a 1031 exchange. With this option, homeowners essentially purchase a property that is of a similar value to the one they just sold. It does not exempt a person from paying it entirely, but it can delay the payments significantly.

There is a lot for home sellers to consider when thinking of capital gains, which is why homeowners should consult with a real estate expert or financial manager before making any major decisions. Deductions, exemptions, and exchanges can be complicated, so it's important to determine the numbers before the actual transfer of the property.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.

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