The Tax On Real Estate Transaction Profits

Feb 19, 2024 By Triston Martin

What about when you sell your home? Do you have to pay capital gains tax? Since a home is considered a capital asset, any profit you make from selling an appreciated property may be subject to capital gains taxation.

In the first year of filing a joint return, you will pay no capital gains tax on the first $250,000 profit. An exemption of $500,000 is given to married couples.

What Is The Rate of Taxation on Real Estate Capital Gains?

By Internal Revenue Service (IRS) standards, you can avoid paying capital gains tax when selling your property if it qualifies as your primary residence. You must have lived in the home for at least two years out of the past five.

If you purchase a home and decide to sell it a year later due to a significant increase in its value, you will be subject to either the short-term or long-term capital gains tax, respectively.

However, the long-term capital gains tax charged on the profit may be excluded in whole or in part if you have held the house for at least two years and qualify under the principle residence requirements.

The Two-in-Five-Year Rule

Identifying the primary residence is a crucial consideration for taxpayers who own more than one property. Only a primary home qualifies for the deduction from federal income taxes, but the IRS gives taxpayers some latitude in deciding whether a property meets that criteria.

It's time to apply the "two in five" rule. To put it another way, if you have spent at least 730 consecutive nights in a home during the past five years, you can consider that home your principal residence. The 24 months can be spread out whichever you choose.

The Taxation of Real Estate Capital Gains

Let's say you spend $30,000 on a brand-new apartment. You'll live there for a year, rent it out for three, and come back for another year when the renters go. You get $450,000 for the condo after holding it for five years.

Because the gain is less than the exclusion threshold, no CGT is owed. Think of a different conclusion where the price of homes in your neighborhood increased by a factor of ten. The condo sells for $600,000 under this scenario. A tax of $50,000 must be paid on the profit made from selling an asset.

Restrictions And Prerequisites

You can avoid paying capital gains tax on the sale of your property if you do so and are in compliance with all IRS rules. However, the eligibility requirements have certain caveats, which are explained on the IRS website.

You are only allowed to use this exemption once every two years. You can only sell your second house tax-free once more than two years have passed since you sold your first property, even if you've lived in both for at least two of the past five years.

Capital Gains Tax On The Sale of a Home

As an illustration, think about the following: For $500,000 in 2015, married couple Susan and Robert bought a house. Values of homes in their area soared as the site expanded rapidly. They decided to cash in on the rising property price market by selling their house in 2022 for $1.2 million.

Profits from the transaction totaled $700,000. They were eligible for a $500,000 exclusion since they filed jointly as a married couple, meaning that only $200,000 of their capital gains would be liable to taxation. They've reached the 20% tax rate threshold with their joint income. Consequently, their tax on capital gains was $40,000.

Income Tax on Investment Property Capital Gains

Real estate is often classified as a primary dwelling for personal use or investment property. The primary residence of a property owner is the home in which they spend most of their time. What if the house is not your primary abode but rather an investment property?

Property that is bought or repurposed to generate income or profit for its owner(s) or investor(s) is known as an investment or rental property (s).

Comparing A Vacation Home To A Rental Property

A second house, or vacation home, is any residential property that is not the primary residence of its owners. Its primary function is to house guests for brief periods. Many homeowners turn their second houses into rental properties when they aren't utilizing them.

Rent payments can be used for the home's mortgage and other upkeep costs. Nonetheless, there are a few considerations. Rental income from a second house is not subject to taxation if the rental period is less than 15 days.

Related Articles