How to avoid capital gains tax when selling a house?

Summary 

What are capital gain taxes? 

Owning a home is not just about having a place to call your own; it's an investment.  

Selling a house is a transaction that (hopefully) unlocks the accrued value that has appreciated within those four walls. However, like the sale of most assets, any profit realized from the sale of your house will have tax implications.  

As the term implies, capital gains tax is incurred when the "gain" in the value of a capital asset, such as selling a house for a profit, triggers a tax liability on that financial gain.  

Simply stated, capital gains taxes on a house are levied on the profit made from the sale of a capital asset. This profit is the difference between the sale price of the property and its original cost, commonly known as the basis. 

Why do I have to pay capital gain taxes when selling a house? 

Capital gains taxes are a way for the government to capture a share of the financial gain that results from the sale of an asset.  

Let's break this down with an example: 

Imagine you bought a house for $400,000 and later sold it for $525,000. The $125,000 difference is considered a capital gain and is liable for taxation. Depending on how long you owned the property, the income falls into either short-term or long-term capital gains.  

Short-term capital gains tax is a tax applied to profits from selling an asset you’ve held for less than a year and are paid at the same rate that you would pay on your ordinary income. 

Long-term capital gains tax is a tax applied to assets held for more than a year. The long-term capital gains tax rates are 0%, 15% and 20%, depending on your income.  

A financial advisor can help you navigate the complexities of paying capital gains tax on a house, ensure that you make informed decisions, and minimize your tax liability. By answering just a few questions, Unbiased will connect you to an SEC-regulated financial advisor perfectly suited to your needs. Get matched with an advisor now.  

How are capital gain taxes calculated? 

Capital gain taxes are calculated on the difference between the sale price and the acquisition price of the property. Your total income level plays a crucial role in determining the capital gains tax you owe on the sale of your house. 

Here are the details on long-term capital gains rates for the 2024 tax year: 

Let’s return to the example from above to see this capital gains calculator in action. 

Let’s say that your current annual income is $120,000 a year. You acquired the house for $400,000, owned it for more than one year and then sold it for $525,000. Your total income for the period would amount to $245,000, placing you in the 15% rate for the capital gain on the sale of your property. The $125,000 profit on the sale of the property would, therefore, incur a 15% capital gains tax liability of $18,750.  

How can I avoid capital gain taxes when selling a house?  

While it might seem like paying capital gains taxes when selling a property is inevitable, there are legitimate ways to minimize or avoid capital gains tax on a house, and there are several loopholes you can use.  

Here are three effective strategies: 

1. Live in the property 

If you've lived in the house as your primary residence for at least two of the last five years, you may qualify for the Primary Residence Exclusion. This allows individuals to exclude up to $250,000 of capital gains from their income or $500,000 for married couples filing jointly. 

2. Invest in Real Estate Opportunities Zones (OZs) 

Opportunity Zones were created to spur economic development by providing tax benefits to investors. By reinvesting the proceeds from the sale of a property into a designated Opportunity Zone, you may defer capital gains taxes. 

3. Implement a tax-deferred sale. 

This involves structuring the sale of the house in a way that defers the recognition of capital gains. One common approach is an installment sale, where you receive the sale proceeds over an extended period, spreading the tax liability across multiple years. 

What are 1031 exchanges, and how can they help defer capital gains tax? 

A 1031 exchange, also known as a like-kind exchange, is a provision in the Internal Revenue Code. It allows you to reinvest the full proceeds from the sale of one property into another like-kind property, effectively postponing the capital gains tax until you sell the new property.  

The key advantage of a 1031 exchange is the ability to defer taxes as long as you keep exchanging properties on a continuous basis. There are, however, several stipulations that must be adhered to in order to take advantage of this provision to avoid capital gains tax when selling a house:  

What expenses can be added to the cost basis of my property to reduce capital gains? 

You can reduce your capital gains tax on a house by increasing the cost basis of your house. This involves adding certain expenses to the original purchase price, including: 

Can capital gains tax laws change, and how can I stay informed about updates that may affect me? 

Tax laws can change over time. To stay informed about potential updates: 

Need more information? 

Navigating capital gains on the sale of a house requires awareness, strategic planning, and professional guidance. By understanding the basics of capital gains taxes, you can explore effective strategies to minimize or avoid paying these taxes.  

It's always advisable to seek the expertise of a financial advisor, particularly when dealing with substantial tax payments. Let Unbiased match you with a trustworthy advisor who can help you to reduce or eliminate paying capital gains tax and guide you toward a better financial future.