When selling your home, apart from the market conditions and prices, there’s one more thing that you should acquaint yourself with. Regulations. There are quite a few laws and regulations that govern the real estate sector and the most important one is tax laws.
Any profit you make from a house sale may be subject to capital gains taxation. The government collects the tax depending on the profit you make.
In this article, we look at what capital gains taxes are, how they operate, and how to avoid them when selling your home.
What is a Capital Gains Tax?
A capital gains tax is a fee levied on the profits resulting from the sale of assets such as real estate properties, stocks, and bonds. A capital gain is defined as the difference between the selling price and the original cost.
The capital gains tax applies to any individual who sells a home to earn profits. However, if you use the money to buy a new house where you would stay for long, the government will not tax the earnings as a capital gain. But instead, it will tax it as a business income.
How Capital Gains Tax Works
Once you sell any property, say your home, you will automatically initiate the capital gains tax. The tax doesn’t apply to assets that have not been sold. The assets that the Internal Revenue Service (IRS) taxes commonly include stocks, bonds, and tangible property such as homes and cars.
The government will only tax you if you have a positive capital gain.
So, what’s a positive capital gain?
If the selling price is greater than the buying price, the net gain is positive.
But if the value of the home depreciates at the time of sale, you will not pay the tax. That is because the selling price would be lower than the original cost.
Difference between Short-Term and Long-Term Capital Gains
There are two types of capital gains tax. Short term and long term. The tax that applies to you depends on how long you’ve held the property for. The tax rates are different too.
Short-Term Capital Gains:
If you sell a property within a year of purchase, you will incur a short-term capital gain. The tax rates for such transactions is identical to whatever your income tax rate is at the time of the sale.
Long-Term Capital Gains:
If you hold a property for more than two years before selling it, you will incur a long-term capital gain. Given that the government encourages holding properties for a long time, the tax rate for these transactions are considerably lower.
How a Capital Gains Tax Works for the Married and Unmarried
When selling your home, the government may exclude you from paying capital gains tax to some extent. However, that may depend on your marital status.
If you’re married, the IRS will not tax up to $500,000 of your home’s capital gain.
If you’re not married, the government will not tax up to $250,000 of your home’s capital gain.
Let’s say that you bought a house at $100,000. Later on, you decide to sell it at $750,000. Your capital gain will be $650,000. If you are single at the time of selling, the government will subject $400,000 to taxation. But if you are married, the government will only subject $150,000 to tax.
However, if the property in question wasn’t your primary residence for at least two years, you lose all the tax breaks. If you’ve already claimed a tax break for another home within the last two years, you can’t get any now.
How to Avoid the Capital Gains Tax
Owning the House for Two Years or More
To qualify for a tax break, you must have owned the house for at least two years. It should have also been your primary residence for at least two years. Additionally, you can’t get a tax break if you’ve already claimed it within the last two years.
On the other hand, if you sell the house within two years of your ownership, you are also liable for quite a few may incur additional charges. More importantly, if you sell your home within two years, the government will consider your profits as a short-term gain. That can be considerably more expensive than taxes for long-term capital gains.
Proof of Home Improvements
The money you spend on improving your home will not be part of your capital gains tax when you sell your home. The simple reasoning is that the amount you spend on improving your home is an inherent expenditure of a home sale.
The capital gains tax excludes home improvement costs from taxation. Keeping the home improvement receipts can save you from paying much capital gains tax given that they will serve as evidence of expenditure.
Understanding Real Estate Regulations
Before selling your home, always go through the real estate regulations of your state. Sometimes, there are special provisions that apply to your state and those provisions might help you get a tax break.
One rule that applies to all states is that if you’re selling your home to move to another state for work, you won’t have to pay any capital gains tax.
Always Seek Guidance from a Professional Real Estate Agent
One way to avoid as much tax as possible is by hiring an expert local real estate agent. These agents usually have hundreds of deals under their belts and know exactly what taxes apply in your particular situation and how you can avoid them.
One way to hire great real estate agents is to get in touch with a Clever Partner Agent. Given that Clever only partners with the very best agents in your area, you can rest assured that they know all about taxes and how you can avoid them.
Clever partner agents charge a simple flat fee of $3000 or 1% if your home sells for more than $350,000.