6 Things to Know About Capital Gains When Selling a House
Capital gains taxes are an important factor for some homeowners when selling their house. Whether they have to pay this type of tax after selling their home depends on the value of the property, if the house was used as a second home or a primary residence, and if the home was used as a rental or investment property.
Knowing these things about capital gains can help homeowners determine how much they are likely to owe after selling their home. If they're going to owe capital gains taxes, they should set aside some money to use when the taxes are due to make the experience easier. Sometimes, capital gains taxes can be thousands of dollars. The following information about capital gains can help homeowners who are selling their property.
Capital Gains Taxes and Adjusted Cost Base
Capital gains taxes are taxes that are applied to the sale of an asset, like a house. Capital gains taxes are usually applied to the difference between the adjusted cost base and the final sale price when the house sells.
The adjusted cost base is the original cost of the house added to the cost of any improvements made after the home was purchased. Imagine, for example, that a homeowner purchases a house for $275,000 and makes improvements that cost $75,000. If the homeowner sold the property, the home's adjusted cost base would be $350,000.
Short-Term vs. Long-Term Capital Gains Taxes on Housing
The first thing to understand is the difference between short and long-term capital gains. If you've held an asset for less than one year, including real estate, the profit you make when you sell is, in general, considered a short-term capital gain. However, there are some exceptions. Any property you hold for longer than one year before selling falls into the category of a long-term asset.
Calculating capital gains taxes on real estate can become complicated because there are unique conditions and requirements that apply in specific cases. One is known as an unrecaptured gain for real property, and it might apply if depreciation had been reported previously; in this case, the tax rate on any profit can be 25%.
Short-term capital gains tax is computed and levied based on standard income tax rates. Sales by estates and trusts are taxed slightly differently, with rates that can vary from 10-37%. Long-term capital gains tax is based on tax filing status and is payable at only three different rates: Zero, 15%, or 20%, based on filing status and income level.
Capital Gains Does Not Apply to All Home Sales
Homeowners selling their primary residence will only have to pay capital gains taxes if they make over a certain amount on the sale of their home. This is called an exclusion. For example, single people do not have to pay capital gains taxes on the first $250,000 made selling their primary residence, while married couples do not have to pay capital gains taxes on the first $500,000.
If the $350,000 home was sold by a single person for $750,000, their profit would be $400,000, and they would have to pay capital gains on $150,000.
$750,000 (sale price of the house) - $350,000 (adjusted cost base) = $400,000 (profit)
$400,000 (profit) - $250,000 (exclusion) = $150,000 to be taxed
If that same house was sold by a married couple, they would not have to pay capital gains taxes. Capital gains taxes apply to second homes and rental properties, except in certain circumstances. Homeowners who lived in their second home as a primary residence for a certain period may treat the home as a primary residence. Sellers can check with their accountant to find out if exclusions apply to their situation.
Capital Gains Exclusions for Military
Military families still have to pay capital gains taxes in some circumstances, but the exclusions are applied differently and more favorably. Exclusions are complicated, and not all people connected to the military may be eligible for these capital gains exclusions, so homeowners who want to be sure that the exclusions apply to them should work with an experienced accountant.
Ownership and Use Test to Determine Capital Gains
The ownership and use test can help homeowners determine whether their home will be subject to capital gains or if it will fall under exclusions. Homeowners must use a home as a primary residence for two of the last five years for exclusions to apply.
For example, a homeowner who buys a home, lives in it as a primary residence for the first two years, then rents the house for an additional six years would be subject to capital gains taxes. However, a homeowner who purchases a home, rents it to tenants for six years, and then lives in the house for the last two years before selling may qualify for exclusions when they sell.
When Do I pay Taxes after Selling my House?
In either case, if capital gains tax is due on the sale of real property, it is payable only after the sale is finalized, calculated, and reported in conjunction with the yearly income tax return. Proper record-keeping is imperative, and professional legal and accounting advice is advisable. Any money due will be payable by the established tax deadline for the pertinent reporting year.
Talk to an Expert to Understand Capital Gains During Your Home Sale
Home sellers who have questions or concerns about capital gains taxes should speak with an accountant or an attorney, as there may be some ways that their capital gains taxes can be minimized when the house sells. If home sellers are hoping to increase the adjusted cost base of their property, they should always keep receipts for home improvements to find out from their accountant what improvements qualify.