What to Know About Capital Gains Tax When Selling Your Home

Selling a home often generates a decent profit for sellers. When there is a profit, sellers must consider the possibility of paying taxes on capital gains. Sellers do not always need to pay capital gains taxes, and there are several exceptions that they should be aware of as they plan. By including the topic of capital gains tax in your checklist for moving to a new home, you'll better be able to anticipate upcoming costs and implement a few strategies to reduce the tax burden.

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

Capital Gains Tax Basics

Certain property types, including real estate, count as capital assets. What people do with that asset when they are done with it can affect their tax liability. Simply put, a capital gain happens when someone sells a capital asset for more than they paid. The capital gain is the difference between the original purchase and sale prices, with a few standard exclusions. Similarly, a capital loss happens if a person sells a capital asset for less than they paid for it. Sellers might not have to pay capital gains taxes, but they should keep it in mind as they plan to sell their homes.

When to Pay Capital Gains Taxes

Most of the time, sellers do not have to pay capital gains taxes on the sale of a primary home. It is worth remembering that the definition of a primary home does not simply mean that the seller occupies the home at the time of sale. The seller or an immediate family member must live in the home during the year of the sale to qualify it as a primary residence. Otherwise, there are a few times when sellers can avoid capital gains tax liability. For example, if someone transfers property to a spouse, they would not need to pay taxes on the transfer. In most other cases, capital gains taxes may be a factor in the sale.

Estimating Capital Gains Taxes

To determine how much they may have to pay in capital gains taxes, sellers should understand how the calculation works. Most people are required to pay taxes on half of the gain if they do not qualify for an exemption due to primary residence or another reason. For example, if someone purchased a home for $500,000 and sold it for $750,000, the capital gain, in this case, could be $250,000. The seller would be liable for taxes on half, which is $125,000. That amount would be counted as income on the seller's tax forms and taxed at whatever rate the seller pays.

Capital Gains Tax Deductions

One of the most common home selling mistakes is failing to strategize for reducing capital gains tax liability. The amount of capital gains tax liability depends on the cost base for the property, not simply the original purchase price. When people buy property as a residence or investment, they often make value-adding home renovations to the property during the time that they own it.

These investments in the property can, in many cases, be used to create an adjusted cost base at the time of sale. For example, if a property owner spends $20,000 upgrading the kitchen, they may be able to increase the original cost base by $20,000. In effect, they could exclude that $20,000 from the capital gain calculation. Sellers should keep records of all investments and upgrades to the property as proof.

Estimate Gains Taxes on Your Home Sale

Although many sellers will not have to pay capital gains taxes, it is a possibility for many people who sell a property. Planning for them is thus one of the keys to reducing home selling stress. Keeping capital gains taxes in mind can also help sellers plan the best time to perform upgrades, especially if they plan to sell the home within a year or two.

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