Americans are increasingly facing capital gains tax when they sell their homes. In 2023, “roughly 8%” of home sales were hit with capital gains tax, which marks “more than double the share in 2019,” said The Wall Street Journal, citing real estate data firm CoreLogic.
This uptick is a result of rapidly rising home values, coupled with the fact “that, unlike other tax provisions, this exemption is not adjusted with inflation,” said The New York Times. Because the limit on how much profit from a home sale is exempt has not been indexed for inflation, “a $500,000 profit when the law was introduced in 1997 is equal to only about $262,000 today,” said the Times, based on the same CoreLogic study.
With this tax on the rise for home sellers, here’s what you need to know about when it applies, how much it runs, and whether there is any way to avoid it.
What is the capital gains tax on real estate, and when does it apply?
Put simply, “when you sell your home for more than what you paid for it, you could be subject to capital gains tax on the profit,” said NerdWallet. In other words, this is a tax that applies to the net gain on a home sale, which “is calculated by subtracting the asset’s original cost or purchase price (the ‘tax basis’), plus any expenses incurred, from the final sale price,” said Bankrate.
Whether you will pay capital gains tax on a home sale that resulted in a profit depends on how much of a profit you made, how long you lived in the home you sold, and what type of property it was (e.g. your primary residence or an investment property). That’s because of the home sale exclusion, which offers a tax break for homeowners who meet certain criteria.
Under IRS rules, single filers can exempt up to $250,000 in profit, while married couples filing jointly can exempt up to $500,000. However, to qualify, “you need to have owned the home and used it as your primary residence for at least 24 months of the five years leading up to the sale,” said the Journal.
In other scenarios, or if profit on the home sale is higher than the full exemption, capital gains tax may apply.
How much is capital gains tax for home sales?
Your capital gains tax rate “depends on several factors,” said Bankrate, including “your income tax bracket,” “your marital status,” “how long you’ve owned the house” and “whether the house was your primary residence, a secondary residence or an investment property.”
For the 2023 tax year, those with a taxable income of $44,625 or less ($89,250 if married and filing jointly) “are not subject to capital gains taxes,” said Bankrate. Meanwhile, if your taxable income is “between $44,626 and $492,300 as a single filer, or between $89,251 and $553,850 if married and filing jointly, you would pay 15%” on the profit from a home sale. Those who earn above those amounts would pay a rate of 20%.
The above refers to long-term capital gains tax rates. However, “if you owned the home for a year or less before selling, short-term capital gains tax rates may apply,” said NerdWallet, and that rate “is equal to your ordinary income tax rate, also known as your income tax bracket.”
Is there any way to avoid capital gains tax when you sell?
As mentioned, there is a home sale exclusion, which can exempt you from paying taxes on a certain amount of profit from a home sale. To get that, however, you must have lived in the house for at least two of the five years prior to the sale. As such, if you are hoping to avoid capital gains tax, it’s helpful to make sure you’re meeting that residency requirement.
Similarly, to avoid short-term capital gains tax, you will want to avoid selling in less than a year.
Another tip, said NerdWallet, is to “keep the receipts for your home improvements.” That’s because “the cost basis of your home typically includes what you paid to purchase it, as well as the improvements you’ve made over the years,” so if you can prove “your cost basis is higher, your exposure to the capital gains tax may be lower.”