When you sell a property, the profits you earn may be subject to capital gains tax. This tax applies to the profit made when you sell an asset, like real estate, for more than its original purchase price.
The amount of tax you owe depends on how long you held the property and whether certain exemptions apply. Understanding capital gains tax is crucial to avoid any surprises when you sell your home.
What is Capital Gains Tax on Real Estate?
Capital gains tax is levied on the profit from selling any asset, including real estate. If you sell a home for more than you bought it, the difference is considered a capital gain, which may be taxable. The tax rate varies depending on whether the gain is short-term (less than a year) or long-term (over a year).
Short-Term vs. Long-Term Capital Gains
- Short-Term Capital Gains: Taxed at higher rates if the asset is held for less than one year.
- Long-Term Capital Gains: Assets held for over a year are taxed at a lower rate.
For example, selling a home for $400,000 that was originally bought for $300,000 results in a $100,000 capital gain.
Impact of Capital Gains on Real Estate Sales
The tax on real estate gains depends on the difference between the sale price and the property’s adjusted basis. This basis includes the original purchase price, any improvements, and depreciation deductions for rental properties.
For properties held over a year, long-term capital gains tax rates apply. Homeowners may also qualify for exclusions, reducing or even eliminating the taxable gain on the sale of their primary residence.
Exemptions and Deductions
There are key exemptions that can help reduce your capital gains tax liability, especially for homeowners. If you lived in the property for two of the last five years before selling, you can exclude up to $250,000 of gains ($500,000 for married couples filing jointly).
Investors may also benefit from strategies like the 1031 exchange, which defers taxes by reinvesting in similar property. However, depreciation taken during ownership can lead to depreciation recapture, which may increase your tax liability.
