Capital gains tax is the income tax you pay on gains from selling capital assets—including real estate. So if you have sold or are selling a house, what does this mean for you?
If you sell your home for more than what you paid for it, that’s good news. The downside, however, is that you probably have a capital gain. And you may have to pay taxes on your capital gain in the form of capital gains tax.
Just as you pay income tax and sales tax, gains from your home sale are subject to taxation.
Complicating matters is the Tax Cuts and Jobs Act, which took effect in 2018 and changed the rules somewhat. Here’s what you need to know about all things capital gains.
What is capital gains tax—and who pays it?
In a nutshell, capital gains tax is a tax levied on possessions and property—including your home—that you sell for a profit.
If you sell it in one year or less, you have a short-term capital gain.
If you sell the home after you hold it for longer than one year, you have a long-term capital gain. Unlike short-term gains, long-term gains are subject to preferential capital gains tax rates.
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What about the primary residence tax exemption?
Unlike other investments, home sale profits benefit from capital gains exemptions that you might qualify for under some conditions, says Kyle White, an agent with Re/Max Advantage Plus in Minneapolis–St. Paul.
The IRS gives each person, no matter how much that person earns, a $250,000 tax-free exemption on capital gains from a primary residence. You can exclude this capital gain from your income permanently.
“So if you and your spouse buy your home for $100,000, and years later sell for up to $600,000, you won’t owe any capital gains tax,” says New York attorney Anthony S. Park. However, you do have to meet specific requirements to claim this capital gains exemption:
- The home must be your primary residence.
- You must have owned it for at least two years.
- You must have lived in it for at least two of the past five years.
- You cannot have taken this exclusion in the past two years.
If you don’t meet all of these requirements, you may be able to take a partial exclusion for capital gains tax if you meet certain exceptions (e.g., if your job forces you to move before you live in the home two years). For more information, consult a tax adviser or IRS Publication 523.
What’s my capital gains tax rate?
For capital gains over that $250,000-per-person exemption, just how much tax will Uncle Sam take out of your long-term real estate sale? Long-term capital gains tax rates are based on your income (pre-2018 it was based on tax brackets), explains Park.
Let’s break it down.
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For single folks, you can benefit from the 0% capital gains rate if you have an income below $40,400 in 2021. Most single people will fall into the 15% capital gains rate, which applies to incomes between $40,401 and $445,850. Single filers with incomes more than $445,851, will get hit with a 20% long-term capital gains rate.
The brackets are a little bigger for married couples filing jointly, but most will get hit with the marriage tax penalty here. Married couples with incomes of $80,800 or less remain in the 0% bracket, which is great news. However, married couples who earn between $80,801 and $501,600 will have a capital gains rate of 15%. Those with incomes above $501,601 will find themselves getting hit with a 20% long-term capital gains rate.
- Your tax rate is 0% on long-term capital gains if you’re a single filer earning less than $40,400, married filing jointly earning less than $80,800, or head of household earning less than $54,100.
- Your tax rate is 15% on long-term capital gains if you’re a single filer earning between $40,401 and $445,850, married filing jointly earning between $80,801 and $501,600, or head of household earning between $54,101 and $473,750.
- Your tax rate is 20% on long-term capital gains if you’re a single filer earning more than $445,851, married filing jointly earning more than $501,601, or head of household earning more than $473,751. For those earning above $501,601, the rate tops out at 20%.
Don’t forget, your state may have its own tax on income from capital gains. And very high-income taxpayers may pay a higher effective tax rate because of an additional 3.8% net investment income tax.
If you held the property for one year or less, it’s a short-term gain. You pay ordinary income tax rates on your short-term capital gains. That’s the same income tax rates you would pay on other ordinary income such as wages.
1031 exchange. This allows you to sell your property and buy another one without recognizing any potential gain in the tax year of sale.
“In essence, you’re swapping one investment asset for another,” says Re/Max Advantage Plus’ White. He cautions, however, that there are very strict rules regarding timelines and guidelines with this transaction, so be sure to check them with an accountant.
If you’re opting out of the rental property investment business and putting your money in another venture that does not qualify for the 1031 exchange, then you’ll owe the capital gains tax on the profit.
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