Understanding Capital Gains On A Home Sale: A Guide

If you’re selling a house, the goal is to make a profit. If you do, congratulations are due. With the capital gains on a home sale, there may be taxes due as well. We’ll go over the tax liability considerations involved in residential property sales. Every situation is different. If you have any doubts as to your individual tax circumstances, consult a tax preparer or financial advisor.

What Is Capital Gains Tax On A Home Sale?

Capital gains tax is applied after the sale of any asset that increases in value. Many home sellers have to pay capital gains tax when they sell their primary residence and its value appreciates. Home sellers may qualify for an exclusion of up to $250,000 from their taxable value, or up to $500,000 if filing jointly with a spouse if there is a gain from the home sale.

You calculate capital gains by figuring out your cost basis in the property. If you buy a home, and do nothing else to it until you sell it, your cost basis in the property is the purchase price, plus fees and closing costs deemed acceptable by the IRS:

• Abstract of title fees
• Transfer or stamp taxes
• Recording fees
• Survey fees
• Legal fees
• Owner’s title insurance
• Charges for installing utilities

Beyond that, your cost basis includes any payments you made that would normally be paid by the seller (as long as the seller didn’t reimburse you). In the case of construction, your cost basis is the cost of the land plus your expenses in constructing the property.

There are also capital improvements to take into consideration. These are home improvements that contribute to the cost basis of your home. If you made a $50,000 renovation to your home originally bought for $150,000, the cost basis for your home would increase to $200,000.

It’s important to note that regular repairs don’t count as improvements, so you can’t add to your cost basis if you replace a broken window. However, you can do so if you undertake a larger project to replace all the windows in your home. Additionally, if you receive any tax credits for your home improvement projects, you have to subtract the value of the credits from your basis.

How Capital Gains Tax Works On A Home Sale

To figure your capital gains tax on a home sale, the first thing to do is subtract the sale price from your adjusted cost basis. You can also subtract your home selling costs, including real estate agent commission, advertising and legal fees. What you’re left with is the amount of capital gains tax you theoretically owe. There’s an important exemption to discuss.

Under IRS policy, you’re allowed to exclude up to $250,000 of capital gains from your home sale ($500,000 if married filing jointly), if you meet both of the following tests:

• You’ve owned the home for at least 2 years in the previous 5-year period.
• The home has served as your primary residence for at least 2 years in the 5 years leading up to the home sale.

The 2-year periods in which you owned the property and used it as your principal residence can be two different periods.

Once you’ve figured out your tax liability after any applicable exclusions, your tax rate is determined by how long you’ve owned the home. We’ll include tax tables for 2023 and 2024.

Long-Term Capital Gains Rates For 2023

If you’ve owned your house for over a year, it’s considered a long-term capital gain. These rates are much lower than rates for the standard income tax. Here are the long-term capital gains tax rates on real estate for the 2023 tax year, based on your level of taxable income:

Short-Term Capital Gains Rates For 2023

On the other hand, if you’ve owned your house for less than a year, it’s considered a short-term capital gain. This means your rate should be the same as your income tax rate. Here are the short-term capital gains tax rates on real estate for the 2023 tax year:

Short-term capital gains sold by an estate or trust have their own set of tax rates. Here are those tax rates for the 2023 tax year:

Unlike long-term capital gains, short-term capital gains are taxed on a graduated scale as ordinary income would be. Let’s say you’re single and you make $90,000. Every dollar after $44,726 is taxed at a 22% rate, between $11,001 – $44,725, you are taxed at 12% and the first $11,000 you make is taxed at 10%. We’ll have an example in a minute.

Long-Term Capital Gains Rates For 2024

All explanations are already included above, so I won’t rehash them here. Here are the long-term tax rates for 2024.

Short-Term Capital Gains Rates For 2024

Again, capital gains on property and assets held less than a year are taxed at ordinary income rates.

How To Calculate Capital Gains Tax On A Home Sale

When looking to calculate capital gains tax on a home sale, the first thing to figure out is your adjusted cost basis. This is the purchase price of the property, your closing costs when you purchased and any improvements you’ve made to the property. You then add your selling costs. The formula looks like this:

Purchase Price + Lifetime Improvements + Closing Costs + Selling Expenses = Adjusted Basis

To determine your profit, you subtract the adjusted basis from the sale price.

Sale Price - Adjusted Basis = Profit

In many cases, if you’ve been using your property as a primary residence which you’ve owned for at least 2 of the last 5 years, you’ll be able to exclude the gain, subject to limits.

If you don’t qualify for an exclusion, the next step is to determine if it’s a long- or short-term capital gain. If you’ve owned the property for more than a year, it’s a long-term gain.

In the case of a long-term gain, you multiply your profit by the capital gains rate for your income level:

Applicable Capital Gains Tax Rate × Profit

If you’ve owned the property for less than a year before selling, any profit you make is added to your regular income and taxed at ordinary graduated income tax rates as high as 37%. The formula gets a little more complicated as well, but the easiest thing to do is look at the IRS tax tables and determine the highest tax percentage that applies based on your taxable income.

Start by adding your profit into other income that would be taxed at ordinary rates.

Home Sale Profit + Other Ordinary Taxable Income = Total Taxable Income

Once you have your total taxable income, you multiply the difference between your income and the lowest income level in your tax bracket and add the IRS constant.

Your highest tax rate × (Your Taxable Income minus the low-end of your tax bracket) + IRS Constant = Taxes Paid

If that sounds confusing, I get it. It helps to understand how the IRS writes it. Let’s pretend your income was $180,000 all in with the home sale in 2024. For a single individual, your total taxes due would be approximately $17,168.50 plus 24% of every dollar over $100,525. The $17,168.50 is the IRS constant and is meant to incorporate calculations for all the taxes before you get to your final bracket.

While we could speak forever on home sale calculations, the best way to understand this is through an example.

Capital Gains Home Sale Example

This all makes more sense once you have examples to work from. We’ll go over how this would look for both long- and short-term capital gains in 2024.

Because most people are going to own their home for more than a year, let’s go over the long-term formula before moving to the short-term one. For the first scenario, let’s say you have a $250,000 tax basis in a home you’ve owned for 5 years that sells for $350,000. You make $100,000 per year and file as single.

The formula is:

(Sale Price - Tax Basis of Home) × Applicable Capital Gains Tax Rate

Based on your income, the applicable long-term capital gains tax rate is 15%. If we plug in the numbers, we get:

($350,000 - $250,000) × 0.15 = $15,000

Now let’s say that instead of holding the property for 5 years, you flipped the house after 9 months. Instead of being taxed at a lower amount based on being a long-term capital gain, it’s taxed as regular income. Let’s take a look at what that looks like keeping both the sales price and the tax basis from the previous example. Let’s start with determining taxable income:

Sale Price - Tax Basis of Home + Wages = Taxable Income

Plug in the numbers:

$350,000 - $250,000 + $100,000 = $200,000

Referring to the IRS tax tables for single individuals, your applicable tax is approximately $39,110.50 plus 32% of every dollar over $191,950.

$39,110.50 + 0.32 × ($200,000 - $191,950) = $41,686.50

This is the amount you could expect to pay if you didn’t qualify for exemptions which would fully or partially wipe this away.

How To Avoid Capital Gains Tax On Sale Of A Home

If you’re trying to avoid paying capital gains tax, there are several things you should look at in attempting to eliminate or limit your liability.

• The 2-out-of-5-year rule: Those who both own their home and use it as their primary residence for at least 2 years in the 5 years prior to selling the home can qualify for a capital gains tax exclusion of up to $250,000 ($500,000 if married filing jointly). The period of ownership and primary residency don’t need to be the same 2 years. The 5-your test is also able to be suspended for up to 10 years if, as a member of the armed forces, foreign service or intelligence apparatus, you were at least 50 miles from your main home or residing in government housing under government orders for at least 90 days or an undefined time frame.
• Get a proper cost basis: In determining your cost basis, make sure you include the purchase price of the property, allowable fees and closing costs as well as any cost normally paid by the seller that you ended up paying. If you built the home yourself, the cost of the land plus your construction cost is your cost basis. Additionally, you can include certain major improvements you’ve made to the home over time, but not repairs. Finally, when you sell the home, you can include sales expenses like real estate agent commission. The higher your cost basis, the lower your profit and tax liability.
• Partial exclusions: Even if you don’t meet the standards for the 2-out-of-5-year rule, you may qualify for a partial exclusion of your tax liability for capital gains if you have a move that’s work or health related or due to other unforeseeable events. Consult a tax advisor.
• 1031 Exchange: In a 1031 exchange, investors can sell property and defer their capital gains tax liability as long as they reinvest the money from the sale in a similar investment property. You still owe the tax, but the liability is delayed until you sell an investment property without reinvesting in another property. For example, let’s say you profit $250,000 from the sale of one investment property and put it into another. If you then decide to sell the second investment property for $250,000 profit without reinvestment, your total capital gains tax liability at that time is $500,000.

Capital Gains On Home Sale FAQs

Now that we’ve touched on many of the elements of calculating capital gains tax on a home sale, let’s run through some questions you still may have.

How much is capital gains tax?

The amount you paid in capital gains tax depends on how long you’ve held the property and your profit. To calculate profit, you need to know your cost basis in the home, which includes the original purchase price or construction cost, allowable closing costs and fees, qualifying improvements and selling expenses. Consult a tax advisor.

When do you pay capital gains tax?

Most people are required to pay all taxes, including capital gains tax, by Tax Day, which is April 15, 2024, for the 2023 tax year. If you’re self-employed or have another special situation, you may be required to file quarterly. In any case, you report your capital gain by filling out Form 8949 and reporting the gain or loss on Schedule D of Form 1040.

How does capital gains tax work on rental properties?

Rental properties work a little bit differently due to section 1031 and the potential for depreciation. Section 1031 exchanges involve the deferral of tax liability for the sale of an investment property until you stop investing the proceeds in other investment properties.

With depreciation, you can limit your tax liability for income from rental properties on the basis of a standard degradation in value with age. However, when the property is sold, the portion of your capital gain that comes through depreciation could be recaptured by the IRS with up to a 25% tax rate in addition to your standard capital gains liability. Consult a tax advisor.

Is there capital gains tax on inherited property?

Yes. However, it’s important to note that if you inherit a property from someone who died prior to or after 2010, your basis is the fair market value of the home on the day of the person’s passing. If you happen to have inherited property from someone who passed in 2010, special rules apply and you should consult a tax advisor.

Although there are exceptions to this, if someone is gifting a house to you, you generally receive what’s known as a step up in basis. This means your adjusted basis in the home starts from whatever it was on the day that the transfer was made.

This means that if the person originally paid $100,000 for the home, gifted it to you when the value was $300,000 and you sold it when the value was $400,000, your tax liability is only $100,000. Speak with a financial advisor about the particulars of your situation.

The Bottom Line

The amount of capital gains tax you owe in a home sale depends on several factors, the first being how long you’ve owned the home. If it’s been a year or more, there are special lower capital gains tax rates. If it’s less than a year, sale proceeds are taxed as ordinary income. You’re taxed on your profit, which is the sale price minus your adjusted basis.

It’s important to note that many people qualify for a full or partial exclusion from capital gains taxes. You should always consult a tax professional about your individual circumstances. If you’re ready to sell your home, get connected with one of our Partner Agents.