What homeowners need to know about taxes and the sale of their home
What are capital gains?
Capital gains are profits made from selling an appreciable asset, such as a house, artwork, car, or stocks. The government taxes this income, though it works a bit differently from how regular income is taxed.
Both the federal and state governments tax capital gains at a lower rate than regular income. Additionally, the government has varying tax rules for different classifications of assets. For sales of primary residences, the first $250,000 of profits are generally not taxed at all if you file your taxes as single. Similarly, if you’re married and file taxes jointly, the first $500,000 of profits from your home sale are generally not taxed.
If falling within these parameters, the home seller can qualify for the capital gains exclusion, or what the IRS refers to as the Section 121 exclusion.
Kaminsky gives an example of a single filer who originally bought a house for $600,000 and later sold it for $1 million, which would result in a $400,000 profit. There, Kaminsky explains, a single filer would likely only have to pay taxes on $150,000 of the profit, but the first $250,000 would be tax-free so long as they qualify for the Section 121 exclusion.
What’s the difference between short-term and long-term capital gains tax?
It is also important to note that there is a difference between short-term capital gains and long-term capital gains. Short-term capital gains are profits made from selling an asset that was owned for one year or less. These profits are taxed at the same rate as ordinary income, which is typically taxed at a higher rate than long-term capital gains.
To put it simply:
- Short-term capital gains (sold in less than a year): Taxed as ordinary income (10%-37%).
- Long-term capital gains (owned for over a year): Taxed at 0%, 15%, or 20%, depending on your income bracket.
So, if you sell a house that you’ve owned for less than a year, the profit will likely be taxed at the same rate as your regular income. If possible, wait at least one year before selling to benefit from lower long-term capital gains tax rates.
How much is capital gains tax?
Capital gains tax rates vary depending on your income. If you’re a single filer and make $48,350 annually or less, you will likely pay zero taxes on capital gains. The rate increases to 15% for single filers who earn between $48,351 and $533,400 per year, and 20% for single filers who earn over $533,400 per year, according to current IRS tax formulas.
Married filers who file jointly will likely pay zero taxes if their combined incomes are less than $96,700. The tax rate increases to 15% for those making between $96,701 and $600,050, and 20% for those making over $600,050.
Additionally, most states collect capital gains tax. The same rule for profits under $250,000 for single filers and $500,000 for joint filers on primary residences applies to state taxes, too. Some states, like Alaska, Florida, Nevada, Texas, and Washington, don’t collect any capital gains tax. Most of the remaining states charge at a rate between 3 and 7%; whereas California taxes capital gains at the highest rate in the country at 13.30%.
Do I have to report the home sale on my tax return?
You generally only need to record your home sale on your tax return if you turned a profit of $250,000 or more as a single filer or $500,000 or more as a joint filer. In that case, you will likely be eligible to exclude the first $250,000 or $500,000 of profit and record the remaining amount on your tax return.
However, if you receive an informational income-reporting document such as Form 1099-S, Proceeds From Real Estate Transactions, you must report the sale of the home even if the gain from the sale is excludable, according to the IRS.
How do I report my home sale profits on my tax return?
You must report the sale on IRS Form 8949 and transfer the totals to Schedule D on your Form 1040 if:
- You made a profit above the $250,000 (single) / $500,000 (married) exemption.
- You sold a rental or investment property (these don’t qualify for the exemption).
