A capital gain occurs when you sell something for more than you purchased it for, which is particularly true when selling a home. The good news is that there are ways to avoid paying a capital gains tax on your home sale. And since the idea is to keep as much profit in your pocket as possible, today, I wanted to discuss the facts about capital gains taxes.
First things first: capital gains taxes can be extremely costly if you’re not careful. This is because any gain that you have made from a significant investment (vehicles included) must be reported to the IRS at tax time. The good news is that there is a qualifying homeowners exemption that can help you avoid capital gains taxes.
For example, if your home is your primary residence, you more than likely will not need to pay capital gains taxes. However, please keep in mind that the following criteria must be met:
- You owned the home for a total of at least two years in the five-year period before the sale
- You used the home as your primary residence for a total of at least two years in that same five-year period
- You haven’t excluded the gain from another home sale in the two-year period before the sale
If you meet these conditions, you can exclude up to $250,000 of your gain if you’re single, $500,000 if you’re married filing jointly. Also of note, the exemption is only available once every two years.
One of the more popular ways people avoid paying a capital gains tax is to conduct a 1031 Exchange. You may have heard of this referred to as a “like-kind exchange” as well. In this scenario, the homeowner would sell their current property and reinvest the proceeds into a similar property. This cycle can go on indefinitely as long as you keep rolling the sales proceeds into another investment property.
If you still have capital gains after taking advantage of the exemption, you should turn your attention to lowering the amount of taxable profit or gains you have. There are a variety of qualifying deductions, these being some of the most common:
- Repair costs to a home or investment property
- Any improvements/upgrades you have made, like adding on or renovating
- Lost investment property income due to non-paying rental tenants
- The cost of legal, professional, and fees to evict a tenant or find a new one
- Any closing costs from the property sale
Please remember to keep detailed, organized records, along with copies of your receipts, invoices, credit card statements, and bills that will help support your expense claims. This is extremely important in case you are ever audited.
Perhaps the best course of action is to sit down with your tax professional to discuss capital gains taxes in more detail. They can offer advice specific to your unique situation and advise you accordingly about the best course of action.
I’m a local real estate professional who has decades of experience in the Pasadena area. I am available to assist you in buying or selling a home, so please contact me if you would like to schedule a time to discuss your needs. Best wishes for a healthy and safe holiday season ahead!