In my career as a real estate agent, I have met with a few clients eager to sell a home that they had just recently purchased.  Whether it was for a job relocation or a change in life circumstances, most were surprised when I asked if they were aware of capital gains taxes that they would need to pay when selling.  These taxes can be substantial.  Here is what you need to know about capital gains taxes and how to find out if you can be exempt from paying the taxes.

What are capital gains taxes?

Capital gains are a tax imposed by the IRS on the profits of the sale of a home.  The profit is considered taxable income.  In simple terms, this means that if you purchased a home for $200,000 and sold it for $350,000, then $150,000 would be considered taxable income.

Who pays capital gains taxes?

Anyone who sells a home and makes a profit from the sale is subject to capital gains taxes.  Typically, investors who purchase and flip homes would pay capital gains taxes (unless they use a 1031 exchange) because they make a profit from repairing and then selling the homes in a short amount of time.  There are exemptions to the capital gains taxes too which is why many homeowners don’t pay them (more on that below). 

How much will the capital gains taxes be?

There is not one answer that fits all.  The taxes are calculated based on your marital status, your income tax bracket, how long you have owned the house, and if it was your primary residence.  The tax is applied to only the profit of selling the home and not the whole sales price. For example if you lived in a home for a year and made a profit of $50,000 by selling the home for $350,000, then the taxes would be applied to the $50,000 profit and not the $350,000 selling price.

When do I have to pay capital gains taxes for a home?

If you meet any of these criteria, then you have to pay capital gains taxes

  • The home wasn’t your principal residence.
  • You owned the property for fewer than two years.
  • You didn’t live in the house for at least two of the last five year period before you sold it.

How do I avoid paying capital gains taxes?

If you don’t want to pay capital gains taxes, then you need to live in the home as your primary residence for more than two years.  When you sell a home, the IRS has a rule that allows many people to exclude the profit from the home sale from their income.  If you file your taxes as a single, then you can exclude up to $250,000 of a profit from the sale of your home.  If you are married and filing jointly, then you can exclude up to $500,000.  For most individuals, these exclusion amounts cover the amount of profit they made from selling the home.  It is important to note that this exemption is available for use once every two years.

For example, you sell your home for $300,000. Your originally purchased the home for $150,000. The home was your primary residence for the past seven years. The profit from the sale is $150,000. Using the exemption, you can exclude this $150,000 profit from your income and avoid paying the tax.

As always, if you are ever in a situation where paying capital gains taxes is a concern, it is always best to consult a tax professional before you decide to place your home on the market. The rules for taxes are always changing, so you want to know the most current information before making an decisions.