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Tax Tips for Home Sellers: Capital Gains

Tax Tips for Home Sellers | PorchLight Real Estate Group Denver

Home Selling & Capital Gains Tax

If you sold your home for more money than what you bought it for, you may be subject to capital gains tax. However, it’s possible to keep more cash in your pocket if you meet the requirements.

Essentially, capital gains is a tax you’re required to pay when you sell an asset that has increased in value since you purchased it. For example, you bought your home for $410,000 in 1999 and recently sold it for $650,000. Your profit or capital gain is $240,000 and subject to taxation.

However, you can exclude all or part of that gain on your federal taxes if you meet basic criteria and profit thresholds. You may not even need to report it on your taxes! 

How Do I Avoid Capital Gains Tax When Selling My Home?

First, there is the exemption threshold. If you file your taxes as single, the first $250,000 in gain is exempt from taxes. For married couples filing jointly, that amount doubles to $500,000. Looking at the example above, a $240,000 gain would go entirely in your pocket (not the government's) whether you file as single or married. 

In addition to the threshold, you must meet three basic qualifications:

  1. You must have owned the home for at least 2 years out of the last 5 (up to the date of closing). If you’re married and file jointly, only one spouse has to meet the ownership requirement.

  2. You must also have lived in the residence for at least 2 of the previous 5 years. This is cumulative, not consecutive. All that’s required is 24 total months. However, unlike the ownership requirement, each spouse must meet the residence requirement individually. Let's say you bought a property and rented it out for 3 years, then lived in it as your primary residence for the next two years—that would qualify you for the exemption.

  3. You meet the IRS “look-back” requirement of not claiming an exemption in the last 2 years. If you didn't sell another home during the 2-year period before the date of sale (or, if you did sell another home during this period, but didn't take an exclusion of the gain earned from it), you meet the look-back requirement.

Eligibility exceptions may come into play if you don't clearly meet all of the criteria above. You can read more about each on the IRS website—however, circumstances that may qualify you for a full or partial exclusion of gain include:

  • Separation or divorce that occurred during the ownership of the home. 
  • Death of a spouse during the ownership of the home. 
  • Your previous home was destroyed or condemned. 
  • You were a service member during the ownership of the home. 
  • You acquired or are relinquishing the home in a like-kind exchange. 
  • You took or were transferred to a new job in a work location at least 50 miles farther from the home than your old work location.
  • You moved for health-related reasons such as to obtain or provide care for yourself, your spouse (co-owner), or a family member. 
  • Other unforeseeable events.

Remember that any exceptions must be proven to the IRS, so always talk to a licensed financial professional to better understand your tax obligations. Your PorchLight agent would be happy to recommend a local expert to help you with tax preparations.

How Much Is Capital Gains Tax?

Your tax rate will differ depending on your income and filing status. Here’s a quick chart to give you a better idea:

A couple of examples:

  • Steve bought a condo 5 years ago for $150,000 and sold it in 2021 for $450,000, netting him a gain of $300,000. Since he files his taxes as single, the first $250,000 is excluded leaving a $50,000 gain. Steve also makes $65,000 annually, so his capital gains tax rate would be 15% and he would therefore pay $7,500 in taxes.

  • Alex and Jennifer are married and file jointly. They purchased their home in 2001 for $500,000 and sold it at the end of 2021 for $1.3 million, giving them a capital gain of $800,000. The first $500,000 is excluded, but their combined income is $625,000 annually. So they would land in the 20% tax rate column. Their capital gains tax on $300,000 is $60,000.

How to Reduce Your Tax When Selling

If you sold your home in 2021 and it looks like you’re going to be required to pay capital gains tax, there are ways to potentially reduce how much you might need to pay. First, you can deduct significant improvements from the profit of your home sale (receipts will be required). This does not mean general maintenance, but substantial items such as: 

  • Increasing square footage by adding a bedroom, bathroom, or garage
  • Exterior improvements such as a deck, fence, or sprinkler system
  • Installing new HVAC fixtures and/or ducting
  • Updating to a new roof, windows, or siding
  • Adding insulation to the attic, walls, or floors
  • Installing a septic system, water heater, or whole-home filtration system
  • Modernizing the kitchen with new cabinets, counters, appliances, etc.
  • Updating the flooring throughout
  • Adding a fireplace

So, if you're single and it looks like you'll be paying taxes on $50,000 in gains—but you put $50,000 into installing new HVAC and turning your kitchen into a chef's paradise—you may be able to decrease or eliminate the need to pay taxes. 

In addition, you can potentially deduct sale-related expenses—an appraisal, closing, escrow, document prep, title search and advertising fees. You will likely receive a statement listing these costs at closing, but it’s always a good idea to keep the receipts for your expenses.

What Else Do Sellers Need to Know?

Typically, if the amount you gained is exempt and you meet the qualifications above, you won’t need to report your home sale on your tax return. If you do have a taxable gain, use the information on Form 8949 to report it on Schedule D (Form 1040).

There’s still a lot to learn about capital gains taxes. What if you sold a home you inherited? What if you’re an investor who owned the home for less than two years? These are both great questions, each with its own tax implications. 

Click here to read the full IRS publication on capital gains or consider finding a financial or tax professional to ensure you avoid either paying or overpaying on taxes.

Final tip—notify the USPS and the IRS (Form 8822) of your new address to ensure you receive all correspondence relating to your home sale.

If You Plan to Sell Your Home This Year

Talk to a PorchLight agent about preparing a no-obligation Comparative Market Analysis on your home. Unlike some of the real estate search sites, we don’t use a generic algorithm to determine home values—numbers that are often overinflated. 

Your agent will look at the local market as a whole and comps in your area, as well as take into consideration the age, size and state of your home along with any improvements that you might have made. You’ll then receive an accurate and up-to-date report of your home’s value.

Knowing your home's value will give you an idea of any tax implications. Keep in mind that in our low-inventory market, you could potentially get an offer over that figure which could increase your tax obligation.

Your agent can walk you through different sales scenarios and if possible, help you sell before you cross the exemption threshold.

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