Many people are currently asking, “Do I pay taxes when I sell my house?” as they look to release the increased equity in their homes – thanks to the recent housing boom – and seek a new home to live in for themselves and their families.
For those who can’t wait, here’s the short answer:
It is highly unlikely you will need to pay tax, known as “Capital Gains Tax,” when you sell an asset like a house. The Internal Revenue Service (IRS) allows all homeowners a sizable tax break, known as an “exclusion,” should they sell their house for a profit – as long as specific criteria are met. This exclusion normally covers any tax liability.
That’s the short answer.
However, it is in your best interests to check out our comprehensive guide provided below on Capital Gains Tax, which gives you all the relevant information you need, with easy-to-follow examples, to be able to answer the question in our title completely and correctly.
We’ll tell you all about Capital Gains Tax, what the tax is applied to, what the specific criteria is that need to be met by law to take advantage of the IRS tax exclusion when selling your house, and much, much more.
It may be a longer answer than the short one provided above, but unlike that answer, this is complete – it is everything you need to know.
- Do I Pay Taxes When I Sell My House?
- What is Capital Gains Tax?
- How Does Capital Gains Tax Apply to Real Estate?
- Capital Investments: Calculating The Value of the Property
- IRS Capital Gains Tax Exclusions
- Are You Liable to Pay Full Capital Gains Tax?
- Capital Gains Tax Rates
- 2022-2023 Capital Gains Tax Long-Term Rates
- Capital Gains Special Circumstances
- The Important Records & Documents on Your Homeownership You Must Keep
Do I Pay Taxes When I Sell My House?
When anyone sells a house in the U.S., they can become liable for Capital Gains Tax on the profit they have made from selling the property. However, the tax is not just applicable to profit from private houses.
What is Capital Gains Tax?
“Capital Gains Tax” is a federal and state tax that applies to any asset you legally own and then sell for profit, such as financial securities, like stocks and bonds, and tangible assets, such as real estate, cars and boats, and so on.
Therefore, the money you make on selling your home – for most people, this is likely to be the most expensive asset you will ever own – is liable to this tax. Keep reading to understand how the tax is calculated and how to avoid a big tax bill.
How Does Capital Gains Tax Apply to Real Estate?
The first major consideration when understanding capital gains tax is that the tax applies to your profit on the asset’s sale – the difference between what you have originally paid for an asset (your cost basis) and the amount you sell the asset for (your agreed sale price).
In the case of your home, this will be the difference between the house’s original agreed purchase price, as found on the property deed, and the sale price as shown in the new purchase agreement and recorded as the “agreed price.”
As we stated earlier in this article, it is unlikely you will need to pay capital gains tax on the sale of your home, and the reason for this is that most people, dependent upon both their tax filing status and their home’s sale price, are eligible for an IRS exclusion.
Capital Investments: Calculating The Value of the Property
If you have invested in the property by making capital investments – installing a new roof, a swimming pool or air conditioning, or remodeling the kitchen – you can adjust the original cost of the house by adding the cost of these improvements.
Capital improvements add significant value to the property, and they do not include costs for routine maintenance or minor repairs.
The property’s new value for tax purposes is known as “the adjusted basis.”
Keeping Home Improvement Receipts
As you can see, you must keep all the relevant home improvement receipts that provide clear evidence of the capital improvements you have made to the property, as these can significantly decrease your exposure to capital gains tax.
For more information on the importance of keeping certain records and documents during your ownership of the property, see our section on “The Important Records & Documents on Your Homeownership You Must Keep” towards the end of this article.
If the property has depreciated in value during your ownership, the adjusted basis must also reflect this.
Lastly, suppose you postponed paying taxes on the gains made from selling a previous home (which was allowed before mid-1997 for homeowners who used the profits to buy a more expensive replacement house). In that case, you must also subtract that gain from your adjusted basis.
IRS Capital Gains Tax Exclusions
The current exclusions for selling real estate were introduced in the Taxpayer Relief Act of 1997; see below:
What is the IRS Exclusion for Capital Gains Tax?The IRS typically allows you to exclude up to:$250,000 of capital gains on real estate if you’re single, and$500,000 of capital gains on real estate if you’re married and filing jointly.
In addition to the above capital gains tax exclusion limits, in order to qualify the property must have been your principal place of residence, and you need to have lived in the property for a minimum of 2 years during the 5 years prior to its sale.
Are You Liable to Pay Capital Gains Tax?
You would be liable to pay tax on the whole profit of your home sale if any of the following factors are true:
- The house was not your principal residence
- You owned the property for less than 2 years during the 5-year period prior to the sale
- You did not live in the house for at least 2 years in the five-year period prior to the sale
Important: People who are registered disabled, and those in the military, Foreign Service or intelligence community can get a tax break on this part – see IRS Publication 523 for more details
- You have already claimed the $250,000 or $500,000 tax exclusion on another home sale during the 2-year period prior to the sale of this home
- You purchased the house through a like-kind exchange (which is swapping one investment property for another, and legally known as a 1031 exchange) during the past 5 years
- You are subject to expatriate tax, which applies to U.S. citizens who have renounced their citizenship or long-term residents (as defined in IRC 877(e)) who have ended their U.S. resident status
Capital Gains Tax Rates
If it is the case that you are liable to pay tax on all or part of the money you made on the sale of your house, you will need to work out what rate of capital gains tax applies to you.
Short-Term Capital Gains Tax Rate
Typically applies if you have owned the asset for less than a year. The rate is equal to your ordinary income tax rate, also known as your tax bracket.
Long-Term Capital Gains Tax Rate
Typically applies if you have owned the asset for more than a year. Many people qualify for a 0% tax rate, and everybody else pays either 15% or 20%, depending on their filing status and income – see below for the different long-term rates.
|Tax-filing status||0% tax rate||15% tax rate||20% tax rate|
|Single||$0 – $41,675||$41,676 – $459,750||$459,751 or more|
|Married, filing jointly||$0 – $83,350||$83,351 – $517,200||$517,201 or more|
|Married, filing separately||$0 – $41,675||$41,676 – $258,600||$258,601 or more|
|Head of household||$0 – $55,800||$55,801 – $488,500||$488,501 or more|
Once you have established the rate of capital gains tax that applies to you, and you are aware of your exclusion status, you can then calculate what your tax liability will be:
If you are single and purchased a property for $150,000 6 years ago, and sold it today for 375,000, the single exclusion allowance of $250,000 covers all of your liability for capital gains tax – as long as you comply with all the necessary criteria described previously.
If you bought a home 10 years ago for $200,000 and sold it today for $800,000, you’d make $600,000. If you’re married and filing jointly, $500,000 of that profit might not be subject to the capital gains tax – but $100,000 of the gain could be.
Capital Gains Special Circumstances
Even if you don’t meet all of these requirements; there are rules for special circumstances that may allow you to claim either the full exclusion or a partial exclusion, including divorce, bereavement, and “unforeseeable events.”
Acquiring Ownership through a Divorce Settlement
If you acquire ownership of a property as part of a divorce settlement, you can count the time it was owned by your former spouse as the time you owned the home. This means you will pass the 2-out-of-5-year ownership step – but not the residency test.
If either spouse dies, and the surviving spouse has not remarried prior to when the property being sold, the surviving spouse can count the period the deceased spouse owned and used the property toward the ownership-and-use clause in the exclusion criteria.
You may still be able to exclude part of your capital gains tax liability if you sold the property due to work or health reasons or as the consequence of “an unforeseeable event.” To see if you qualify, check IRS Publication 523 for full details.
The Important Records & Documents on Your Homeownership You Must Keep
As you can see, several documents, records, and receipts are an important part of the process for when you sell your property and move on. You will encounter many documents as a homeowner – these are the important documents you must keep:
- Buyer’s Agent Agreement: This is the contract between you and your real estate broker
- Purchase Agreement: This agreement – the real estate purchase agreement – is a legally binding contract signed by the home buyer and the seller confirming the agreed purchase price, closing date, and other terms
- Addenda, Amendments, or Riders: These types of documents alter or amend the terms of your purchase contract
- Seller Disclosures: Sellers are required by law to disclose certain problems with the home, both present, and past, including the use of lead-based paint, pest infestations, and renovations done without a permit
- Home Inspection Report: After your home inspection, your inspector should produce a report with detailed notes on the home’s condition – and any potential problems
- Closing Disclosure: Mortgage lenders must provide borrowers with a closing disclosure (also called a CD) at least three business days before settlement. This document states your loan term (typically 15 or 30 years), loan type (a fixed-rate or adjustable-rate mortgage), interest rate, and closing cost
- Title Insurance Policy: Title insurance offers protection against any competing claims to a home
- Property Deed: When you take the title and become the sole owner of the property, you’ll receive the property deed – the legal document confirming your new ownership rights
- Capital Investment Receipts: Any official receipts relating to significant home improvements
|For More Information on Capital Gains TaxFor information on ascertaining if you have a gain or loss on the sale of your home, please see IRS Tax Topic 703: Basis of Assets For general information on the sale of your home, please see IRS Publication 523: Selling Your Home and Tax Topic 701: Sale of Your Home|
Better Off Home Buyers Can Help You Move Quickly
At Better Off Home Buyers, we can help you move quickly, just like the hundreds and hundreds of homeowners we have helped to move quickly before. Whatever the reason for you wanting to sell your house – opting for a life change that involves moving to another state, more room for a growing family, or a bigger footprint needed for permanent work-from-home space – we can offer you a handsome cash price for your property
Simply fill out our short form below or dial our phone number directly. You will receive a “no-obligation, no-pressure” cash offer for your property. Our home-buying process is transparent and easy to understand. We close in about seven days, but you can close on the date of your choice.
Contact us at Better Off Home Buyers today.