Updated August 29th, 2019
Have you heard that you’re not supposed to sell a home until after you’ve lived in it for at least two years? While many homeowners will tell you this is because you won’t be able to resell and recoup all of your money (which may be true), there are also tax implications to selling your home early.
Work with a top local agent to discover whether selling your home before two years is a good move and how you can make the most money when doing so.
If you’ve owned your home for less than two years and are considering selling, this guide will help you understand everything you need to know about the financial costs of selling a home early.
Can you sell your house before two years?
While you can legally sell your home the second it becomes yours, there are many reasons why homeowners are urged not to sell their home for at least a few years. Since your home purchase is an investment, unless you’re able to somehow sell it for a much higher price than you bought it for, you’ll lose the money you initially invested within the home.
At the start of a mortgage, almost all your payment goes to interest, so it can take a while to build equity even though your payments remain the same throughout the entire loan term.
When you sell your home, you’ll also be responsible for paying the real estate agents involved in the transaction, traditionally around 6% total between the listing agent and buyer’s agent. This immediately eats away at any equity you’ve built up to this point.
In a best-case scenario, your home will have appreciated in value over the time you’ve lived in it, but that’s not always the case. If your home has depreciated and you don’t have enough equity to make up the difference, you’ll be responsible for paying the remainder of any amount due on your mortgage.
What is the tax penalty for selling your house before two years?
But what if you do sell your home for a profit? The problem is, if you sell your home and you’ve owned it for less than two years, you’ll need to pay capital gains tax on the profit.
Capital gains tax can generally be avoided when selling a home, since sellers can write off up to $250,000 in capital gains tax (or $500,000 for couples), so long as they’ve lived in their home for two years or more.
But if you’re selling before then, you’ll be required to pay capital gains tax, which will be taxed at your ordinary tax rate if it’s short-term (held for less than a year) or less if it’s long-term (more than a year, between 0%-20%).
How do you avoid paying when you sell your house?
The simplest way to avoid paying capital gains tax is to hold off on selling and wait until you hit the two year mark. If you’re eager to move, consider renting your home out and making money off of it in the meantime, rather than potentially losing money by paying capital gains.
Your real estate agent or accountant can offer better insight to provide you with the most profitable solution.
Are there partial exclusions you can qualify for?
If you absolutely have to sell within the two year period, it’s important to work with an experienced accountant to see if you qualify for any tax exclusions. These exclusions vary depending on your specific situation, so be sure to consult a tax expert.
How long do you have to buy another house to avoid capital gains taxes?
There’s no requirement to ever buy another home in order to avoid capital gains taxes when selling your primary residential house. If you sell after two years, you won’t pay capital gains taxes on profits less than $250,000 (or $500,000 for jointly owned homes). There’s no additional requirement to purchase a new home.
Can you sell your house and reinvest in another house and not pay taxes?
If you’re not an investor, there’s no way to avoid capital gains taxes if you sell your home after owning it for less than two years.
If you’re an investor, however, you can avoid paying capital gains with a 1031 exchange. A 1031 exchange allows investors who recently sold a property to purchase a like-property within 180 days of the original property sale.
In order to qualify, investors must find another rental property and close on it within this 180 day window, otherwise they’ll find themselves subject to capital gains tax.
What is the difference between short-term capital gains and long-term capital gains?
Capital gains can be broken down into short-term and long-term capital gains. If you own your home for a year or less, you’ll be taxed at the short-term capital gains tax rate, which is the same as your income tax rate. If you own your home for over a year, you’ll be taxed at the long-term or maximum capital gains tax rate of 20%.
Are there alternatives to selling your home?
If you find you need to relocate for your work, family, or health, there are other options to consider. You could look into renting your home as an AirBnb while you’re away or look for more permanent tenants to rent your home.
By renting your home, you’ll continue to grow your home’s equity, and you won’t have to worry about paying capital gains taxes. Then, once you’ve hit the two-year homeownership mark, you can decide if it’s more beneficial to sell or continue renting the property.
What is the best way to save money when selling your house before two years?
If you have to sell your home before owning it for two years, it’s important to look for the most affordable method possible. Since you’ll need to pay real estate agent fees, you’ll want to find a reputable, yet affordable realtor.
A Clever Partner Agent can help sell you home for a discounted rate. While traditional agents charge 3% for listing fees, Clever Partner Agents only charge $3,000 for listing services (and 1% for homes over $350,000). This means if your home sells for $300,000, you’ll only pay $3,000 for listing services with Clever, while you’d be paying $9,000 just for listing with a traditional agent.
Top FAQs About Tax Penalties When Selling Your Home
Do you have to own a home for 5 years to avoid capital gains?
No. Under federal law, you have to have owned your home for at least two years within the past five years. You’ll also need to make sure your profit doesn’t exceed $250,000 (for single owners) or $500,000 (for married owners) to avoid paying capital gains tax.
How much is capital gains tax on the sale of a home?
The amount of capital gains tax you’ll pay on your home depends on when you’re selling it. If you sell your home in one year or less of purchasing it, you’ll pay the short-term capital gains tax rate, which is equal to your income tax rate. If you sell after owning the home for more than one year, you’ll pay the long-term or maximum capital gains rate of 20%.
If you sell your home after owning it for two years, but do not qualify for the exemption because your profit exceeds the threshold, you’ll also pay the maximum capital gains tax rate of 20%.
How long do you have to reinvest money from the sale of a house?
If you’re an investor and you’re hoping to avoid capital gains tax by purchasing another investment property, you may qualify for a 1031 exchange. A 1031 exchange allows you to purchase a new property within 180 days from the time of the first property sale. Failure to do so will result in capital gains tax being owed.
What qualifies as capital gains?
Capital gains is the increase in value of an asset from when it was purchased to when it was sold. In real estate, this refers to the value of a property. If a property was purchased for $150,000 and is sold for $210,000, the property gains is the difference between the sold and purchased price, or $60,000. This is the amount that is taxed, if capital gains tax is owed.
Can I have two primary residences to avoid capital gains tax?
Even if there are two homes you reside in equally throughout the year, legally only one can be your primary residence. While you can avoid paying capital gains tax on your primary residence if sold after two years (and under the profit threshold), you cannot do so for your secondary residence unless it was your primary residence for two of the last five years.
However, you can only use the capital gains exclusion once every two years, so if you do own two properties that qualify, be sure to time their sales to your benefit, otherwise, you’ll end up owning capital gains tax.