How to avoid paying capital gains tax when selling your home

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Buying a home will probably be the largest purchase of your life, likely costing you hundreds of thousands of dollars. But there are a few perks if you decide to sell it. Like the capital gains tax exclusion.

What is capital gains tax?

Cars, stocks, and bonds can be capital assets. A home is considered a capital asset, too, because it’s a significant piece of property. When you sell a property for more than you paid, it’s called a capital gain.

When you sell a car for more than you paid, you’ll need to report that gain to the Internal Revenue Service. The IRS will then tax your capital gains. Homes get excluded from capital gains tax — as long as you and your home fit the criteria.

How to qualify for capital gains tax exemptions

During a hot housing market, sellers can expect to make a hefty profit. To avoid capital gains tax on your home, make sure you qualify:

  1. You’ve owned the home for at least two years. This might be troublesome for house-flippers, who could be subjected to short-term capital gains tax. This is applied if you’ve owned a home for less than one year. More on that below.
  2. You’ve lived in the home for at least two years. The house you’re selling should be your primary residence, even if the two years you lived there weren’t consecutive.
  3. You haven’t done this recently. As long as you haven’t exempted the gains on another home sale in the last two years, you’re safe.

Steven Wolpow, managing partner of Nussbaum Yates Berg Klein & Wolpow, says the pros are high for homeowners.

“The benefits for owners are obvious,” he says. “There is a tremendous tax advantage when you sell your home at a gain, and this is something that you can repeat again and again.”

While there are limitations on how soon you can benefit from the exclusion after you’ve done it recently, there is no shortage of how many times you can take advantage of it. But there are some limitations.

“(Homeowners) have to keep good records of how much they paid for their home and how much they spent on improvements,” he says. “Also, homeowners have to be aware of the requirement to have used the home for the required period in order to take advantage of the exemption.”

How much you can exempt from capital gains

If you meet the qualifications, how much you can exclude is dependent on your filing status. It’s up to $250,000 for single people and up to $500,000 for married couples filing jointly. To find out how much your capital gain is, subtract the purchase price from the sale price. David Cawley, CFO of FraimCPA, gives an example for a married couple that files joint taxes.

“Let’s say a couple bought a home in 2010 for $150,000 and owned and lived in it until they decided to take advantage of a seller’s market and sold it for $250,000 in 2018.” Cawley says. “Their ‘gain’ on their house would be $100,000, which would have no tax implications because they met all the requirements for capital gain exclusion, and the gain can be left off their tax return altogether.”

Your partnership matters for the exemption as well. As long as your partner lived in the home for at least two years, they qualify, too. You don’t have to be married for that time either — just cohabitating.

It’s also important that neither you nor your spouse has sold a home and used the capital gains tax exemption within the last two years.

A recent change to the rule also allows exemptions for special circumstances. For example, if your spouse has recently passed away, you have at least two years to sell your home and still qualify for up to $500,000 in tax exemptions. Before, you had to sell your home within the same tax year that your spouse died to qualify for the full exemption.

The difference between short- and long-term capital gains

The length of your homeownership matters when it comes to how you’re taxed. It could be the difference in thousands of dollars, depending on the worth of your home and your tax bracket.

  • Short-term: This applies to assets owned for less than a year. The rate is equal to your tax bracket.
  • Long-term: This is for assets owned for one year or more. Depending on your tax bracket, you might not end up paying anything. If you have a higher income, you could end up paying 15 percent or 20 percent.

Cawley says when possible, take advantage of long-term options.

“Long-term gains are always taxed at lower rates than short-term gains, so holding the assets for more than a year will always be the most advantageous tax maneuver,” he says. “There are other financial and investing strategies to consider, so in some instances it still may make sense to sell the assets sooner and take the tax hit. But with all other things being equal, holding the assets more than a year reduces your tax burden significantly.”

If you can meet the requirements for the capital gains tax exemption, enjoy the benefits. Make sure you keep solid records of your home updates, too. Remodeling, newer appliances, and updated floors and windows only improve your home’s value. The capital gains tax break will help you keep costs lower than you think when it comes time to sell.

Written by
Dori Zinn
Contributing writer
Dori Zinn has been a personal finance journalist for more than a decade. Aside from her work for Bankrate, her bylines have appeared on CNET, Yahoo Finance, MSN Money, Wirecutter, Quartz, Inc. and more. She loves helping people learn about money, specializing in topics like investing, real estate, borrowing money and financial literacy.