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Homeowners who sell their home within two years of buying it may face a hefty tax penalty known as capital gains tax.
You could pay up to 37% of the difference between your home’s previous and current sale prices in capital gains taxes — deducting tens of thousands of dollars from your proceeds.
Homeowners can avoid capital gains taxes by waiting two years or more before selling. Of course, not everyone has time on their side. For those who need to sell faster, we gathered the best strategies for minimizing your tax burden.
For instance, our friends at Clever can help you save on commission to offset some of the money you’ll have to pay in capital gains taxes with listing fees of just 1.5%.
Read on to learn more about the financial implications of selling your home before two years — plus what tax exemptions are available if you’re able to wait.
- Home sellers who sell within two years of buying their home may have to pay federal and state taxes known as capital gains taxes.
- Capital gains taxes are determined by tax bracket and location.
- Currently, there are nine states (AK, FL, NV, NH, SD, TN, TX, WA, and WY) with no capital gains tax.
- The IRS offers a limited capital gains tax exemption for those who live in their primary residence for two years or longer before selling.
What are capital gains on house sale?
Capital gains are the profits from the sale of a home or other asset and are generally considered taxable income.
Most homeowners who sell their property have to pay capital gains taxes at the federal and state levels, though this varies depending on where you live.
If you earn a profit when you sell your home, you’ll have to pay taxes on the difference between your home’s original purchase price and its sale price.
You can, however, deduct most expenses from the sale price of your home, which can greatly reduce how much you’ll pay in taxes. Common deductions include:
- Agent’s commission fees
- Appraisal fees
- Attorney fees
- Closing fees
- Escrow fees
- Local transfer taxes
- Title search fees
Once you’ve calculated capital gains, several additional factors determine your final tax bill.
Additionally, state capital gains tax rates vary widely — and some states have no capital gains tax at all.
» JUMP TO: What is the capital gains tax in my state?
Tax tip: In most cases, renovations and home improvement projects count as valid tax deductions. Subtracting these costs from the proceeds of your sale can help reduce the capital gains taxes you owe.
Ready to tackle your home renovation project? HomeAdvisor can help by connecting you to local professionals free of charge!
Calculating capital gains taxes
Let’s say you purchased a home for $250,000 and sold it for $300,000, earning $50,000 in proceeds.
After subtracting $27,000 for closing costs and commission fees, you would only be taxed on the remaining $23,000.
|Original purchase price||-$250,000|
|Deductions (6% commission and 3% closing costs)||-$27,000|
|Capital gains tax||Varies by location and situation|
After one year or less: Short-term capital gains taxes
If you sell your property after owning it for one year or less, you’ll pay short-term capital gains taxes, which currently range from 10-37% (applied to the difference between your home’s original purchase price and current sale price). The tax rate you pay depends on your location and tax bracket.
After more than one year: Long-term capital gains taxes
If you’ve owned your property for more than one year before selling, you’ll pay long-term capital gains.
Your rate could be 0%, 15%, or 20% of your home’s proceeds, depending on your taxable income and whether you’re married or single. In general, long-term rates are more favorable than short-term rates and reward homeowners who wait at least one year before selling.
|Tax status||0% rate||15% rate||20% rate|
|Single||Income less than $80,000||Income is $80,000-441,450||Applies to income that exceeds the 15% limit|
|Head of household||Income less than $80,000||Income is $80,000-469,050 for head of household||Applies to income that exceeds the 15% limit|
|Married filing jointly||Income less than $80,000||Income is $80,000-496,600||Applies to income that exceeds the 15% limit|
|Married filing separately||Income less than $80,000||Income is $80,000-248,300||Applies to income that exceeds the 15% limit|
For those selling an investment property or second home, the only way to diminish capital gains taxes is to hold onto the property for longer than a year so it qualifies for these more favorable terms.
Working with a service like Clever is another way to offset some of your tax burden, so you can keep as much money in your pocket as possible after your sale.
State capital gains taxes
Most — though not all — states require homeowners to pay state capital gains taxes. There are currently nine states that do not have a capital gains tax:
- New Hampshire
- South Dakota
In all other states, tax rates vary considerably depending on your location. For example, homeowners in California pay 13.3%, while those in Nebraska enjoy a lower rate of 6.84%.
What is a capital loss?
A capital loss occurs when a home seller sells their home for less than they paid for it.
For example, let’s say you purchased a home for $250,000, then sold it for $200,000. In this case, your capital loss would be $50,000.
According to the IRS, capital losses can lower your taxable income by either the amount of your total net loss or $3,000 ($1,500 for a married individual filing separately), whichever is lower. If your capital loss exceeds $3,000, you may be able to apply it to future years.
Tips for minimizing capital gains taxes
Live in your home for two or more years before selling
Homeowners who stay in their homes for at least two years before selling can significantly reduce their capital gains taxes:
- Single homeowners can exclude the first $250,000 of capital gains.
- Married couples filing jointly can exclude the first $500,000 of capital gains.
To qualify for this capital gains tax exclusion, you must own and live in your home for two of the five years leading up to the sale.
For example, let’s say you purchased a home for $300,000. After two years or more, you sell your home for $700,000, earning $400,000 from the sale.
After applying the $250,000 tax exemption, your taxable capital gains would decrease from $400,000 to $150,000.
Use an installment contract to defer payment
If you want to spread your capital gains taxes across multiple years instead of paying a big tax bill right away, sell your home on an installment contract.
In this situation, a person or company typically provides a down payment, then pays monthly installments until they own your property. This arrangement spreads your tax burden across multiple years (though you’ll still be responsible for paying the full amount).
If you take this route, it’s important to set clear guidelines and a timeline for how long the buyer will have to pay. There are also regulations and limitations to installment payments, so be sure you understand exactly how to report your income.
Do a 1031 exchange
If you’re selling an investment property, you can do a 1031 exchange to defer paying capital gains taxes. (Note: In most cases 1031 exchanges don’t apply to primary residences or second homes.)
To conduct a 1031 exchange, an investor must sell one investment property and use the proceeds to buy another of “like-kind.” There’s no limit to how many times you can do this, and your capital gains taxes can be continuously rolled over from one investment property to the next.
However, it’s crucial to time your sale carefully. You must close on your new investment property within 180 days of selling your previous property, and you must follow several other rules and regulations.
If you need advice on selling before you’ve owned your house for two years, our friends at Clever can help! They have a nationwide network of real estate agents who can advise you on how to navigate your next sale.
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