When selling your house, seeing how much money you can get from the sale is half the fun! Then tax season comes, and you begin to worry about paying taxes on the nice amount of money you made. Will you pay taxes on the sale of your home?
Will I Pay Taxes on the Sale of My Home?
The tax that most talk about when they talk about paying taxes on the sale of their home is called capital gains tax. Capital gains tax is the tax you pay on the money you make from the house. For example, if you purchased your house for $100,000 and sold it later for $350, you would pay taxes on the gain. The capital gain for that property would be $150,000. There are variations and exclusions to those rules, though. Let’s take a look at them.
Will I pay taxes on the sale of my primary residence?
If you have lived in the house for two of the last five years (not necessarily consecutively)– then you may qualify for the capital gains tax exclusion. The exclusionary rule states that those who are single can exclude up to $250,000 of capital gains from taxes, and married couples can exclude up to $500,000 of capital gains.
You must have lived in the house for two of the last five years, though. Although, you could live in it fully for two years and sell it, or live in it for a year, and live it again for a year three years later– so long as it is all within a five year period. You also must not have excluded the gain from another house within the two year period.
Do I pay taxes on the sale of my investment property?
Taxes on investment properties are a bit different than your primary residence because you are making money off of the property. Here are some of the taxes you do you need to be aware of when selling your investment property:
Pay Back Depreciation Deduction
While you own the investment property, you are allowed to write-off depreciation divided over 27.5 years. This provides an excellent tax break while you own the property, but you have to pay most of it back when you sell the property. Depreciation write-offs allow you to say that because you are renting out the property to tenants, that it is depreciating in value. The reality of the situation is that most of the time, the property actually rises in value rather than depreciates. That’s definitely the hope, anyway. The general idea is that you sell your investment property for so much that the money you pay back in the form of depreciation tax write-offs won’t seem like much at all.
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Capital Gains Tax
Capital gains tax applies the same to investment properties as it does with your primary residence. If you have lived in the house for two of the last five years and have not excluded gains from another home within that period of time, go for it!
Ways to Avoid Taxes
No one really likes paying taxes, especially on a large amount of money! There are a few ways you can avoid paying taxes on the sale of your home.
One of the great ways to avoid capital gains tax is to do a 1031 exchange. A 1031 exchange is when you take one property and sell it. Rather than keeping the money, however, you put it in escrow and use it as a down payment on up to 3 properties within 45 days of closing on the sale of your property. 1031 exchanges help you avoid the gains tax until you either end up selling the property or completing another 1031 exchange.
You are able to complete an unlimited number of 1031 exchanges (within the guidelines). It’s a great way to build your investment portfolio and stretch your money! There are some guidelines with 1031 exchanges that you’ll want to review before capitalizing on it (such as it must be an investment property), but it does not need to be the same type of investment property.
Live in and Sell
Another way many avoid paying capital gains tax is to live in their investment properties. How it works is you find a property with multiple units (up to four units). You live in one unit while you make repairs and rent out the other units. While you are living there, you are getting an income from the other renters and are hopefully living there without having to pay any added money toward your mortgage.
There are many different ways people do this. They may rent out the mother-in-law apartment in their basement, or live in a duplex. The more units you have, the more cash flow you’ll get.
Full-Time Real Estate
It is important to note that if you do invest in real estate, there are ways not to pay tax while you own the home as well. It does depend on your tax bracket and the way you set up your real estate ventures, however. To receive maximum benefits, you want to be full-time in real estate. A full-time real estate professional works a minimum of 750 hours per year on their real estate business and doesn’t have an income from a full-time job. When setting up your real estate company, it’s important to talk to your tax advisor/accountant.
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We aren’t CPAs nor are we in the position to give you financial advice. Although we do our research, it’s important to talk to your personal accountant about any tax questions you may have. Best of luck!
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