How to avoid capital gains tax when selling property | finder.com
How to avoid capital gains tax when selling property

How to avoid capital gains tax when selling property

Tips to minimize — or eliminate — your capital gains tax.

Selling your home is exhausting and expensive enough without the stress of surprise taxes and fees.

When putting your house on the market, taxes are inevitable. But there are few strategies that can help you hold on to more of your money.

As home prices continue to surge, here’s how to minimize how much you pay on your profits — also called a capital gains tax.

What is a capital gains tax?

A capital gains tax is a fee that you pay to the government when you sell your home, or something else of value, for more than you paid for it. For example, if you bought a house years ago at $200,000 and sold it for $300,000, you’d pay a percentage of your $100,000 profit — or capital gains — to the government.

When you make money from selling a house or property, your capital gains tax depends on whether you lived in the house and how long you lived there.

Short-term capital gains

In general, you’ll pay higher taxes on property you’ve owned for less than a year. This is because short-term capital gains are taxed at the same rate as ordinary income. In 2017, that rate is between 10% and 39.6% of your profit, but most people pay around 25%.

Long-term capital gains

With long-term capital gains, you get the benefit of a reduced tax rate that typically doesn’t exceed 20%. If you’re selling a residence or investment property you’ve held on to for at least a year, you’ve effectively lowered your capital gains tax.

Does the capital gains tax apply only to real estate?

No. The IRS can take capital gains tax on anything you sell that makes a profit, including car and other investments, like stocks and bonds. (Most retirement accounts, however, allow you to defer paying taxes on gains until you’re eligible to withdraw money.)

If the price has gone up since you purchased an asset and you plan to sell it, you’ll typically pay capital gains tax on the profit.

Is my primary residence exempt from capital gains tax?

Yes. The IRS allows you skim up to $250,000 off the profit of a primary residence when calculating capital gains tax. That amount jumps to $500,000, if you’re married.

You can typically take advantage of this exemption if you meet three requirements:

  • You’ve owned your home for at least two years in the five years before you’ve looked to sell it.
  • Your home was your primary residence for at least two years of that same five-year period.
  • You haven’t taken a capital gains exclusion for any other property sold at least two years before this current sale.

Staying in your home longer than two years might help you qualify for an exemption. Even if it takes three years to sell it after you move, you could still avoid capital gains tax if you lived in the home for at least two years.

How much will I have to pay?

Most taxpayers miscalculate their capital gains by simply subtracting the purchase price from the selling price. But under the tax code, “purchase price” and “selling price” are much more.

Your purchase price — or “cost basis” — is what you paid for the house or property plus all the taxes and fees you paid when you bought it, typically from 2% to 5% of the cost. You can also include money spent on projects that added value to the property, like that extra bathroom or garage improvements.

On the other end of your investment, your selling price is what you sell your property for minus any commission or closing fees you pay to sell it.

Let’s say that years ago you paid $200,000 for a house. At that time, you paid $8,000 in taxes and closing fees. Since then, you’ve made $30,000 in improvements. In this case, your cost basis is $238,000.

Original purchase pricePLUS taxes and fees at time of purchasePLUS added valueEQUALS cost basis
$200,000$8,000$30,000$238,000

You’ve now sold this home for $450,000. To calculate your taxable profit, you’d subtract your cost basis from the price you sold it for.

Selling priceLESS cost basisEQUALS taxable profit
$450,000$238,000$212,000

Your taxable profit on your recent sale is $212,000. And because you bought the home more than two years ago, you can walk away with your $212,000 tax-free.

How can I reduce capital gains tax on a property?

If your property isn’t exempt from the capital gains tax, here are a few strategies to minimize or reduce it.

Wait at least five years after you’ve bought a property to sell it.

To get around the capital gains tax, you need to live in your primary residence at least two of the five years before you sell it.

Say that you’ve lived in your home for 2.5 years and are now ready to move closer to your job. By renting out the property for another 2.5 years, you’d reach capital gains tax exemption. But be sure to keep your rental stint under three years: After three years, your home becomes an investment property.

Plan to sell a property after you’ve experienced capital losses.

If you’re going through a period in which you’re producing less income than usual, it could be a good time to sell a property. Because your tax rate factors in your income, you can take advantage of a reduced rate.

Let’s say that your spouse leaves her job to pursue studies. Prior to her resignation, your two-income household put you in a higher tax bracket that could mean a capital gains rate of 15%. With your drop in income, you’re now in a lower tax bracket — which means fewer taxes on any home sale during this period.

Track your home improvements or selling expenses.

Don’t miss out on claiming all value you added to your house while living there. Keep track of how much you spend on improvements and upgrades to your property, and reflect that amount in your ultimate cost basis. You’ll need records and receipts when submitting your taxes.

Turn your primary residence into a rental.

Renting your property can be a solid way to cover your mortgage while you live elsewhere. But to be exempt from the capital gains tax, you’ll need to limit how long you rent it. After three years, it’s considered an investment property.

Are there specific exemptions for investment property?

Yes. Investors can look to Tax Code Section 1031 to profit on business or investment properties without paying capital gains tax.

Section 1031 allows you to trade “like-kind” properties to avoid paying taxes on the initial profit. These like-kind properties must be similar: You can trade a retail space for another retail space, but you can’t trade a retail space for a rental property.

If the value of one property is greater than the other, you can add cash to the deal. The person who owns the property of lesser value can pay any difference at the time of sale.

Can I avoid the tax by moving into my investment property?

Yes. If you live in your property for at least two years, it changes the nature of your property from an investment property back to your primary residence. You’re then eligible for the capital gains tax exemption of up to $250,000 (or $500,000 if you’re married).

Say you live in New York City with your spouse. You decide to sell your place in the city, where you’ve lived for the past two years, and move into your vacation home upstate. Since your city apartment was your primary residence, you take your $500,000 profit tax-free.

Your move upstate doesn’t have to be permanent. If you want to ultimately move back to the city, stay in your vacation home at least two years. After two years, that property becomes your primary residence, and you can sell it and pocket another tax-free profit of up $500,000.

Bottom line

Homeownership often comes with the headache of ultimately selling your home. By knowing more about the intricacies of the capital gains tax, you could line up your sale to maximize the profits you make on your home or investment property. And save a big headache at tax time.

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14 Responses

  1. Default Gravatar
    leahApril 16, 2018

    i dont see this on your info page but i was told that if one “exchganges dwellings” by purchasing a new home within a certain time of selling our present one, we can deduct that from the profit that is taxable by capital gains tax.
    is this true? what are the parameters of that exchange and what is saved by it?

    • Staff
      JoshuaApril 16, 2018Staff

      Hi Leah,

      Thanks for getting in touch with finder.

      So far, our page does not discuss any capital gains tax that you can save by exchanging dwellings. However, what is clear is that you can be exempted of the CGT if you meet the following requirements;

      – You’ve owned your home for at least two years in the five years before you’ve looked to sell it.
      – Your home was your primary residence for at least two years of that same five-year period.
      – You haven’t taken a capital gains exclusion for any other property sold at least two years before this current sale.

      Moreover, you can also try doing the tips mentioned on this page to reduce your CGT in case you are not exempted. For example, make sure you live in your primary residence at least two of the five years before you sell it.

      I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.

      Have a wonderful day!

      Cheers,
      Joshua

  2. Default Gravatar
    DaveApril 10, 2018

    Hi! I don’t quite understand the following language “owned your home for at least two years in the five years before you’ve looked to sell it.” Do you have to have owned and lived in the property for at least 2 years regardless of how many years you owned it? I’m selling my primary residence, which I’ve owned for almost 4 years. Would the profit be subject to CG?

    • Staff
      JoshuaApril 11, 2018Staff

      Hi Dave,

      Thanks for getting in touch with finder.

      On our page, it says, “You can typically take advantage of this exemption if you’ve owned your home for at least two years in the five years before you’ve looked to sell it.” It means that for the last five years, you should have owned your home at least two years.

      Of course, that’s just one of the requirements. You also need to have the home you intend to sell as your primary residence for at least two years of that same five-year period. You also should not have taken a capital gains exclusion for any other property sold at least two years before the current sale.

      If you’ve owned your property for 4 years and have lived in it for at least 2 years, given that you did not run a business from it, rented it out or flipped it, and is on land of two hectares or less, you can be exempted from CGT. I would recommend that you look for a tax expert who can take into consideration all aspects of your unique situation and give you a more personalised advice.

      I would recommend that you look for a tax expert who can take into consideration all aspects of your concern and give you a more personalised advice. You may also read more about CGT and its implication on your home from this government website.

      I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.

      Have a wonderful day!

      Cheers,
      Joshua

  3. Default Gravatar
    sharonMarch 28, 2018

    sold 2 homes in the same year. 1st house sold was principle residence for past 20 years. 2nd home sold was vacation home. bought another home which will be our permanent residence. is the 1st sale exempt from capital gains?

    • Staff
      JoshuaMarch 28, 2018Staff

      Hi Sharon,

      Thanks for getting in touch with finder.

      The answer to your question is yes. When you sold your principle residence for the past 20 years, you should be exempted from CGT. The IRS allows you skim up to $250,000 off the profit of a primary residence when calculating capital gains tax. That amount jumps to $500,000, if you’re married.

      As a review, you can typically take advantage of this exemption if you meet three requirements:

      You’ve owned your home for at least two years in the five years before you’ve looked to sell it.
      Your home was your primary residence for at least two years of that same five-year period.
      You haven’t taken a capital gains exclusion for any other property sold at least two years before this current sale.

      Just to add, please note that we are not tax experts. If you need to get a more personalized answer, you may want to visit your local tax office.

      I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.

      Have a wonderful day!

      Cheers,
      Joshua

  4. Default Gravatar
    JoanMarch 27, 2018

    My elderly father put his home of 50 years in an irrevocable trust with the three children as beneficiaries. He is now selling it.
    Am I correct in understanding that doing so blew the opportunity to be able to deduct $250,000 from the sale price before calculating the capital gains?

    • Staff
      JoshuaMarch 28, 2018Staff

      Hi Joan,

      Thanks for getting in touch with finder.

      The answer to your question is yes.

      You need to realize that irrevocable trusts are separate legal entities. When you place your home under an irrevocable trust, you just made it impossible for you to claim the exclusion on capital gains. Remember that the income you get from an irrevocable trust typically stays within the trust. Thus, the trust itself needs to pay capital gains tax on the profit.

      Moreover, it would be helpful if you review the tax brackets covering trusts. Generally, trusts have a smaller tax bracket compared to individuals. Thus, there’s a possibility that your CGT may change dramatically.

      Please note that we are not tax experts. I suggest you find a professional who can provide a more personalized answer.

      I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.

      Have a wonderful day!

      Cheers,
      Joshua

  5. Default Gravatar
    MargaretMarch 19, 2018

    We sold 80 acres we had cattle on. We still owe money on a loan. Does capital gains come out before real estate loan is paid off or after. Our real estate on is one loans on our home and this property. Can we pay off all our real estate loan and pay capital gains on what is left.

    • Staff
      JoshuaMarch 25, 2018Staff

      Hi Margaret,

      Thanks for getting in touch with finder.

      CGT is a fee that you pay when you sell your home, or something else of value, for more than you paid for it. If you earn something from what you sold, then that is subject to CGT.

      In your case, you need to determine if you gain something when you sold your land or property. If not, then you don’t need to pay CGT.

      Your property which is under a loan is a separate entity to the property you sold. So, it doesn’t have any bearing whether you still have a loan or not. As long as you earned something, then you need to pay CGT.

      Please note that we are not tax experts. Thus, it would still be wise to solicit the advice of professional tax agents or you may visit your local tax office to obtain a more personalised answer.

      I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.

      Have a wonderful day!

      Cheers,
      Joshua

  6. Default Gravatar
    ChristineFebruary 15, 2018

    We are planning to sell our home in March however just found out there could be capital gains tax since we have not lived here for 2 years. Our 2 year date is August 29th 2018.
    If we use the profits from the sell of the home to purchase a new one will we still have to pay the taxes? Also, what time period do you have to purchase the new property?

    • Staff
      JoshuaFebruary 24, 2018Staff

      Hi Christine,

      Thanks for getting in touch with finder.

      The answer to your first question is yes. How you intend to use your profit doesn’t factor into the calculations of your taxable amounts after the sale. If you’ve made a profit, that profit is subject to capital gains tax.

      For your second question, it doesn’t matter since again, how you intend to use your profit doesn’t affect how much tax you will be paying.

      I recommend that you look for a tax expert who may take into consideration your situation and give you a more personalized answer.

      I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.

      Have a wonderful day!

      Cheers,
      Joshua

  7. Default Gravatar
    JimFebruary 3, 2018

    Have a capital gain on a home that was sold by the family . Three siblings split the proceeds on $99,000. Our part was $16000. This was my wife’s fathers home he passed in 2011. We all split the upkeep until it was sold. Do we report the gain ?

    • Staff
      JoshuaFebruary 12, 2018Staff

      Hi Jim,

      Thanks for getting in touch.

      Please note that we are not tax experts and so we can only provide general information.

      Based on the information you provided, your profit may be subject to capital gain.

      You report your capital gains by filing with the IRS Form 1040 Schedule D — Capital Gains and Losses.

      I would suggest that you look for a tax expert and discuss your situation. You may also visit this page to know more if money received from the sale of inherited property is considered taxable income or not.

      I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.

      Have a wonderful day!

      Cheers,
      Joshua

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