Capital gains tax is the income tax you pay on gains from selling capital assets—including real estate. So if you have sold or are selling a house, what does this mean for you?
If you sell your home for more than what you paid for it, that’s good news. The downside, however, is that you probably have a capital gain. And you may have to pay taxes on your capital gain in the form of capital gains tax.
Just as you pay income tax and sales tax, gains from your home sale are subject to taxation.
Complicating matters is the Tax Cuts and Jobs Act, which took effect in 2018 and changed the rules somewhat. Here’s what you need to know about all things capital gains.
What is capital gains tax—and who pays it?
In a nutshell, capital gains tax is a tax levied on possessions and property—including your home—that you sell for a profit.
If you sell it in one year or less, you have a short-term capital gain.
If you sell the home after you hold it for longer than one year, you have a long-term capital gain. Unlike short-term gains, long-term gains are subject to preferential capital gains tax rates.
What about the primary residence tax exemption?
Unlike other investments, home sale profits benefit from capital gains exemptions that you might qualify for under some conditions.
The IRS gives each person, no matter how much that person earns, a $250,000 tax-free exemption on capital gains from a primary residence. You can exclude this capital gain from your income permanently.
So, if you and your spouse buy your home for $100,000, and years later sell for up to $600,000, you won’t owe any capital gains tax. However, you do have to meet specific requirements to claim this capital gains exemption:
- The home must be your primary residence.
- You must have owned it for at least two years.
- You must have lived in it for at least two of the past five years.
- You cannot have taken this exclusion in the past two years.
If you don’t meet all of these requirements, you may be able to take a partial exclusion for capital gains tax if you meet certain exceptions (e.g., if your job forces you to move before you live in the home two years).
For more information on capital gains tax, please consult a tax adviser or IRS Publication 523.