There are a lot of considerations to keep in mind when someone is selling a home. Buying and selling homes are often the biggest financial transactions a person will engage in throughout their life. When the buyer's offer is accepted and every line of the contract dated and signed, the seller should be aware of the implications of the sale, particularly any applicable tax implications. While most home sales are exempt from capital gains taxes, there are some situations that will trigger a tax. Understanding these before putting a home on the market can help avoid surprises after the fact.
What Is Capital Gains Tax?
Any large or valuable asset, such as an investment account, a vehicle or a home, can be considered a capital asset. If a person sells a capital asset at a profit, those profits are known as capital gains. A capital gain is defined as the amount of monies received for the asset in excess of its original cost. In most cases, the seller will owe taxes on any capital gains. However, there are exemptions for a lot of taxes, especially those that apply to a person's home.
Capital gains taxes, when they are owed, are also not assessed on the gross profit of a house. They will only be assessed on the net profit, which is the profit after costs. So, if someone buys a home for $250,000 and sells it for $350,000, their capital gains on the sale is $100,000. However, capital improvements to the home, such as additions, are added to the original cost to determine the base cost.
Do Sellers Have to Pay Capital Gains Taxes?
If a home appreciates significantly during the time a seller owns it, significant capital gains are possible. While making a profit on an investment is a good thing, sometimes a new tax burden can temper some of the enthusiasm.
The good news is that very few East Brunswick homeowners will owe capital gains on the profits that they make when they sell their home. Most home sale profits are protected from taxes under the Taxpayer Relief Act of 1997. Under this law, the first $250,000 of profit is tax exempt for single home sellers. For married couples, the first $500,000 is tax exempt. The new tax law in 2018 did not change these exemption amounts.
To get the exemption, a few other conditions must be met. The owner must have purchased the home at least two years ago. They must have resided in the home for at least two of the previous five years. And, they must not have claimed the capital gains exemption within the last two years.
Which Homeowners Are Likely to Owe Capital Gains?
More than one tax professional has said that tax problems are good problems to have. After all, a tax problem means that an individual is making a significant amount of money. Because of how high the exemption is and because of how it protects owners of primary residences, it will usually only apply to people in a few categories:
- those who own second or vacation homes.
- individuals who flip homes for a living and who do not live in the houses for significant amounts of time before they sell.
- people who purchased their properties through like-kind exchanges.
- people who are subject to expatriate laws.
If someone does owe capital gains taxes, they will have to pay either short term capital gains or long term. Short term capital gains taxes applies to assets owned less than one year. These taxes are assessed at the individual's normal income tax rate. Long term capital gains are lower and tend to be between 15 and 20 percent. The exact amount will depend on an individual's tax bracket and filing status.
How Can a Seller Reduce Capital Gains Taxes?
Luckily, if someone is likely to owe capital gains taxes on a home sale, there are a few strategies that can reduce their tax burden when it comes time to sell. The first would be delaying a sale until the minimum time to claim the exemption kicks in. If circumstances make selling before two years an attractive option, consider whether the gains from selling sooner will be enough to offset any additional taxes.
Improvements to the home can also often be used to offset capital gains. Individuals should keep receipts for any changes made to the home so that they can be used to offset any taxes as the time of sale. These improvements can include everything from new plumbing or paint to fences, new windows, remodeling, air conditioning and other improvements.
Every seller's situation is different. Consulting a tax accountant and discussing potential implications early in the selling process can help ensure that there are no surprises at tax time. By understanding what is subject to capital gains and what gets a pass, sellers can keep make sure that more profits stay in their pockets.