What is Capital Gains?

Capital gains tax is a tax that is levied on the profit, or gain, made from the sale of an asset, such as a house. When selling a home, it’s an important consideration for home sellers, as it can have a significant impact on the amount of money they walk away with after settlement.

Let’s explore what capital gains tax is, how it affects home sellers, and what strategies are available to minimize that tax liability.

What is capital gains tax?

Capital gains tax is a tax that is imposed on the profit or gain made from the sale of an asset, such as a house or property. The amount of capital gains tax that a seller will pay is determined by the length of time they have owned the property, the selling price, and the cost basis, which includes the original purchase price, any expenses incurred during ownership, and the cost of any improvements made to the property.

How does capital gains tax affect home sellers?

When a homeowner sells their primary residence, they can exclude up to $250,000 in capital gains from their taxable income if they have lived in the home for at least two of the past five years. For married couples filing jointly, the exclusion is $500,000. This means that if the homeowner sells their home for a profit of $250,000 or less, they won’t owe any capital gains tax.

However, if the profit exceeds $250,000 (or $500,000 for married couples), the homeowner will owe capital gains tax on the amount that exceeds the exclusion limit. The capital gains tax rate varies depending on the homeowner’s income level, and can range from 0% to 20%.

What strategies can home sellers use to minimize their capital gains tax liability?

One strategy that home sellers can use to minimize their capital gains tax liability is to time their sale to take advantage of the exclusion limit. By waiting until they have lived in the home for at least two of the past five years, they can take advantage of the exclusion and potentially avoid paying any capital gains tax.

A 1031 exchange is another option available to real estate investors who want to defer paying capital gains tax on the sale of a property. This allows them to reinvest the proceeds from the sale of one property into another similar property, deferring the capital gains tax until they sell the new property.

In conclusion, capital gains tax is an important consideration for home sellers. By understanding how it works and utilizing strategies to minimize tax liability, home sellers can maximize profits and ensure a successful sale. It’s always a good idea to consult with a tax professional with expertise in this area to get the best advice for your specific situation.