What to know about the capital gains tax on home sales

By Lena Borrelli

Selling your home is an exciting endeavor and hopefully a profitable one, too. However, if your home has increased in value since you purchased it, you could be liable for the capital gains tax, which can eat into your bottom line. Here’s what you need to know about capital gains on a home sale.

How much is capital gains tax?

Capital gains are a type of tax you pay when you sell an asset that has increased in value.

There are both short-term and long-term capital gains taxes. Short-term gains apply to assets owned under 12 months, with the short-term gains rate the same as your income tax rate. Long-term gains apply to assets owned longer than 12 months. There are several factors that impact how much you pay for long-term gains, including your income and filing status:

Long-term capital gains tax 2022

Source: IRS

Do you have to pay capital gains tax on home sales?

The capital gains tax on home sales only applies if you own and live in the home for two of the five years before the sale, and only to profits over $250,000 for single filers or profits over $500,000 if married filing jointly. In other words, you can exempt up to $250,000 or $500,000, depending on your filing status, in sale proceeds from this tax.

However, these capital gains rules don’t apply if you sell a rental or investment property.

There are other cases in which you’ll likely have to pay capital gains tax on a home sale, as well:

• If you already used the exemption for another primary residence sold within the two years before this sale

• If you used a 1031 like-kind exchange to purchase the home in the last five years

• If you’re liable for expatriate tax

How to avoid capital gains tax on home sales

As noted, if you own a rental property, you’re subject to different capital gains rules. However, if you can live in it as your primary residence for at least two years, you could save on capital gains when you sell.

A 1031 exchange is another way to “avoid” capital gains on an investment property, although you’re not really avoiding them, but rather deferring them to a later date. With a 1031 exchange, you swap one property for another and won’t pay capital gains tax at the time of transfer — you simply roll the gains over to the subsequent property.

For a primary residence, you might also be able to exclude some gains if the sale is due to a divorce. There can be other exceptions, which the IRS details in Publication 523.

As with any tax question, consult with a CPA or licensed tax professional for guidance regarding your specific case. Your tax professional might even offer alternative ways to save on capital gains so you can pocket more of your real estate proceeds.

This article is also posted on Bankrate here.