Taxes on selling a house

Summary

What is capital gains tax? 

Many of your most valuable items, from financial products to cars to properties, are classified as capital assets — things you can buy and sell for more money. However, should you sell these assets for a profit, you may need to pay capital gains tax (CGT).  

CGT applies to any profits you have made once an asset is sold. It is taxed in two different ways. First, if you have owned an asset for over a year, you will be taxed at a more generous long-term CGT rate of either 0%, 15%, or 20%.  

Second, if you buy and sell an asset in less than a year, short-term CGT rules apply, and profits you make will be taxed as part of your normal income and can be taxed at higher rates.  

CGT only kicks in once an asset sells, so it can sometimes be forgotten about and be a frustrating expense. However, there are tax exceptions, and some homeowners may not need to pay any CGT at all.  

Do you have to pay tax when selling your home?

In principle, selling your house for a profit means you should pay CGT, but most people won’t need to.  

If you are single-filing your taxes and have lived in your house for at least two of the five years before the sale, the first $250,000 of the profit is tax-free.  

If you are married and filing your taxes as a couple, this tax-free exemption is $500,000. Equally, if you sell your home for less than $250,000 above the price you paid for it, you won’t owe any taxes on the property.  

How much tax do you pay when selling a house?

The exact amount of CGT you are liable for comes down to how you calculate profits generated from the property sale. However, there are a few things to consider when calculating this, and it isn’t always as straightforward as it sounds.  

Firstly, you need to figure out the cost price of your home. This is the total of how much you initially paid for the house and any improvements and investments you have made into the property. You will then need to determine the amount you sold the property for, minus any extra fees you paid. Your profit is then the difference between the two amounts, and unless you sell the property for more than $250,000, you won’t need to pay tax.  

How to avoid paying tax when selling a house

If you are eligible for CGT when selling a house, the good news is that there are a few easy ways to reduce the tax you must pay.  

1.Adjust your cost price

As mentioned above, the cost price is the total cost of your house, including any extra investments you have made. But it can be calculated differently, depending on which expenses and fees you include.  

For example, you can decide to include extra fees you spent on buying the property to raise the cost price of your property. Doing so reduces your profit and can exclude you from paying CGT altogether.  

2.Reduced home sale exclusion

If you sell an asset within a year of its purchase, you can be taxed at a higher rate because your profits are taxed as part of your normal income. However, if you can prove you have a qualified reason, you can still claim a partial exemption.  

A reduced home sale exclusion can exclude your first $125,000 of profit, depending on whether or not you have a qualified reason. Accepted exemptions include changes in health, employment, or any other reason that meant you needed to leave sooner than anticipated.  

3.Use capital losses

If you have accumulated capital losses on other investments, you can use these to write down your capital gains on your property sale. You can only use up to $3,000 of capital losses in a single year to offset other capital gains, but you can carry forward any excess losses to subsequent tax years.  

4.Convert secondary homes into a main residence

You can obtain limited capital gains exclusions by converting a secondary property into your main house. To qualify for the IRS capital gains exemption of the first $250,000 of profits, you need to have lived in a property for two of the five years leading up to the sale. This means you could live in two properties during these five years as long as each house you live in is your primary residence.  

However, rental properties converted into primary residences only earn capital gains exemption during the term that the property was used as a primary residence—in other words, a minimum of two years. So, while you can gain a limited capital gains exclusion, it is only a partial exclusion covering the period when it was your primary residence and not the period it was a rental or secondary home.   

5.Sell in installments 

Selling a property in installments can mean paying reduced CGT compared to receiving a lump sum. With your profits spread over a much longer term, you will realize your gains over a longer period and lower your taxable profits in a single tax year, as opposed to realizing all of your profits in one go.  

Selling a house can mean that you need to pay more CGT than you hoped for. But there are ways to reduce your taxes and protect your investments. Speak to a financial advisor today and find out how to minimize your tax eligibility.