You pay sales tax and income tax – and when you sell your home you may also pay capital gains tax.
What is it? It is the tax on the difference between what you paid for your house and the profit you make when you sell it. Other possessions and property are also subject to this tax.
There are two kinds of capital gains tax: long term and short term. Any sale you make within one year of acquisition is subject to short-term capital gains. These are taxed at the same rate as your other ordinary income.
The Tax Cuts and Jobs Act of 2018 changed the rules somewhat, so here’s what you need to know.
Unlike other investments, the sale of your primary residence benefits from some exemptions.
Under the IRS regulations, each person is entitled to a $250,000 tax-free gain upon the sale of a primary residence. For a jointly owned home, the exemption would be $500,000 – as long as neither party has taken this exemption within the previous two years.
Here are the requirements for taking advantage of the exemption:
- The home must be your primary residence.
- You must have owned it for at least two years.
- You must have resided in the house for at least two of the past five years.
- You may not have taken the exemption on another house within the past two years.
In other words, if you’ve owned a vacation house for several years and would benefit greatly from this exemption, you should move and make it your primary residence for at least two years.
If your employment forces you to move before the required two years, you may still qualify for a partial exemption. If you are in that situation, read IRS Publication 523 or consult with a tax advisor.
How much are long-term capital gains rates?
The rate you’ll pay will be based on your income and your marital status.
The long term capital gains tax rate is 0% if:
- You’re a single filer and earn less than $40,400
- You’re the head of a household and earn less than $54,10
- You’re a couple filing jointly and earning less than $80,800.
Your rate will be 15% if:
- You’re a single filer and earn between $40,401 and $445,850
- You’re a head of a household earning between $54,101 and $473,750
- You’re a couple filing jointly with earnings between $80,801 and $501,600 (yep, you get hit with a marriage penalty)
You’ll pay 20% on long term capital gains if:
- You’re single and earning more than $445,851
- You’re the head of the household earning more than $473,751
- You’re a couple filing jointly and earn more than $501,601
In addition to federal capital gains tax, your state may impose its own version of a capital gains tax, and very high income taxpayers may be subject to an additional 3.8% net investment income tax.
The state of Texas does not impose its own capital gains tax – just one more good reason to live here!
Good record-keeping will help reduce your capital gains tax.
Since this tax is based on the difference between what you’ve invested in your house (the basis) and what you receive when it’s sold, improvements you’ve made will help reduce your tax.
So keep track of things like replacing your roof, finishing a basement, remodeling the kitchen, building a deck, replacing the flooring, installing new windows, etc. All of these activities will add to the adjusted cost basis of your home. Keeping records and receipts will pay off!
Do keep in mind that these expenses must be for improvements – not merely repairs.
Capital gains taxes don’t go both ways.
If you suffer a loss when you sell your personal residence, you won’t pay capital gains tax, but you also won’t get to take a deduction for the loss. If you sell other real estate at a loss, you can take a deduction (subject to limitations), but a loss on your home is considered a personal loss – not business.
The IRS does give heirs a break…
The IRS gives a free “step-up” in basis when an heir inherits the family house. If your parents purchased the family home decades ago, you might be looking at hundreds of thousands in profit over what they paid. Fortunately, you won’t be taxed on that.
Instead, when you sell that house, the cost basis of the house will “step up” to its value on the day your last parent passed away. This is one reason why your attorney will advise you to learn the market value.
If you want to lower future capital gains taxes while getting more enjoyment from your home today…
Come and talk to us about a cash-out refinance or a home equity loan. Then get busy making improvements that will add to the value of your home.
Homewood Mortgage, the Mike Clover Group, is known for our low interest rates, minimal closing costs, fast turn-around times, and some of the friendliest loan officers in Texas.
Call us today at 800-223-7409