Do you have to pay capital gains when you sell a home?

Do you have to pay capital gains when you sell a home?

I get this question a lot as a mortgage planner so I’m going to attempt to answer that today in today’s tip of the week.

Before I get into this question, I want to preface this by saying that I’m not a tax professional. I’m not a CPA. You definitely should consult your tax professional on your specific situation to find out how this will apply to you. And this is just my interpretation of the capital gains laws. Take it for what it is, but here’s my understanding of how it works.

If you’re selling your primary home and you’ve lived in the home since you bought the home and never rented it out, then you have to live in the home for two years or more to avoid capital gains.

What do I mean by capital gains?

Capital gains is a tax that you pay on the profit that you make on the sale of an asset, so in this case your house. Now, if you live in the house for less than two years, but more than one year, you’ll be subject to long-term capital gains tax. If you have lived in the house for less than a year, then you’re going to be subject to short-term capital gains, which is basically that you’re taxed as if that gain is ordinary income. You’re taxed at your regular tax bracket.

When we’re calculating the gain, you take the price you sell the home for, minus the price that you obtain the home for. And the difference is the capital gain. There are ways that you can reduce that profit or that gain. One of the ways is that you can subtract any improvements you made to the home. Now, by improvements I mean actual improvements, not maintenance items. Improvements like putting on a new deck or excuse me, remodeling the kitchen or redoing the driveway, putting up a fence, things like that. As long as you have receipts, you can subtract that from the amount of the gain.

You can also subtract some of the expenses that you incur selling your home. This can help reduce your tax burden if you’re selling the home within two years of buying it.

What if it’s an investment property or a vacation property? Now, I don’t know what the law is on a vacation property or if this the same thing would apply, but on an investment property, when you sell the property, yes, you are going to be subject to the capital gains tax no matter how long you’ve owned the property.

But there’s a way to basically defer the tax to a future date, and that’s called a 1031 exchange. What is a 1031 exchange? This is where you take the gain from the sale of the property and through a tax, I don’t know what you’d call it, deferred event called a 1031, you’re able to roll over that gain into another property. The new property has to be equal or more in value to the one you sold. Or if you buy more than one property, the combined value of those properties has to be more than the one that you sold. But this is a way that you can roll over that gain into the new property, not pay the tax now, but when you sell those properties in the future, you still have to pay the tax on that gain from the original property. That’s how a 10 31 exchange works.

What if you owned your primary, you’ve lived in your primary home for a while, and then you went to rent it out.

The IRS has a rule where if you’ve lived in the home for at least two out of five years, you can still avoid capital gains tax on that home. That’s another little nuance to this law. Now, once again, please, please, please consult your tax professional. Don’t take this as the law or set in stone. This is just my interpretation of the capital gains law, and I am not a tax professional.

Give me a call, email me, or text me if you have any questions on this or any mortgage related topics.