You’ll have to pay capital gain taxes when you sell properties or assets more than the purchasing cost. For example, if you purchase an asset for $100,000 and sell it for $500,000, you’ll have $400,000 profit or capital gains, and you’ll have to pay capital gain taxes on this profit. This capital gain tax includes homes, stocks, vehicles, boats, bonds, and other asset classes.
Capital Gain Tax & Real Estate
Unlike other asset classes, calculating capital gain taxes for homes or real estate is a bit complex. While calculating the capital gain taxes, you’ll have to consider the duration of the property ownership, marital status, usage of the property, etc.
For example, if you sell your home in less than 1 year of purchasing it, you’ll have to pay short-term capital gain taxes, and it can be around 20%-37% of the capital gain or profit. However, if you stay in the house for more than 1 year, the capital gain taxes will drop to 20% of the total capital gain. However, these capital gain taxes can be low as 0% or 15%, depending on your yearly income.
Again, there is a capital gain tax exemption depending on your marital status. According to the IRS, if you’re single, you’ll be exempted $250,000, and for a married couple, it’ll be $500,000. However, if you’re thinking about getting divorced and selling your home, there is a slight change in capital gain tax exemption.
3 Ways to Avoid Capital Gain Taxes on Home Sale
1. Establish the Rental House as Your Primary Residence
According to the IRS, homeowners don’t have to pay any capital gain tax on the primary residence (as explained above). But on the other hand, if you have an investment property or a rental property, you’ll have to pay capital gain taxes.
If you’re planning to sell your rental house, to avoid paying capital gain taxes, you’ll have to establish your rental home as your primary residence. However, when you do this, your main home will lose its primary residence status. But don’t worry, there is a solution for it.
After selling your rental house, you’ll have to show your main house as a primary residence again, and you cannot sell the house for two years. Thus, you can avoid paying capital gain taxes on your rental house.
2. Collect the Receipts of Your Home Improvement Expenses
The cost basis includes the total cost of purchasing a property and the expenses made in its lifetime. IF you have a higher cost basis, your capital gain taxes will be lower. That’s why when doing remodeling, kitchen upgrades, installing new windows, fences, and HVAC, keep the receipts of every expense. Thus, you’ll be able to show more cost basis and be exempt from the capital gain taxes.
3. Use 1031 Exchange
With this method, you can avoid capital gain taxes for an indefinite time. You’ll have to reinvest the money that you’ll get from your previous property in a similar type of house or investment.
