Buying a new house is exciting, but selling the same house can bring mixed feelings. Whether the decision to sell is strategic or due to a shift in life circumstances, one thing you don’t want to overlook is capital gains tax.
So, at what amount of selling price do you need to pay capital gains tax? More importantly, when are you exempt from paying capital gains tax?
There are various factors that determine the capital gains tax rate on your property:
First, it depends on your:
– Income level;
– Marital status;
– Length of time owning the property;
– Whether the property is your primary residence or a secondary home used for investment.
For a primary residence, the capital gains tax thresholds are $250,000 for single filers and $500,000 for married couples filing jointly.
This means that if you are a single filer who bought your house for $250,000 and sell it for $700,000, you won’t have to pay taxes on the initial $250,000 (initial price) or the next $250,000 (exempt threshold), but you will owe taxes on the difference between $500,000 and $700,000. Your capital gain is $200,000, and that’s the amount you’ll be taxed on.
Your income level will determine the capital gains tax rate you need to pay on this $200,000.
According to the Internal Revenue Service (IRS), for tax year 2023 and beyond, single filers with incomes equal to or less than $44,625 and married couples filing jointly with incomes below $89,250 have a zero capital gains tax rate.
For single filers with incomes over $44,625 but less than or equal to $492,300, the rate goes up to 15%.
Similarly, for married couples filing jointly with incomes over $89,250 but not exceeding $553,850, the rate is also 15%.
If your taxable income exceeds the threshold set for the 15% capital gains tax rate, you will owe a 20% capital gains tax.
In the event of selling a home within two years of a spouse’s death and not remarrying, a person can qualify for a $500,000 exemption. Essentially, you are still considered a married couple, allowing you to benefit from the higher tax-free amount when selling your primary residence.
However, to do this, the seller and the deceased spouse must not have previously enjoyed a similar tax exemption on another property sold within the two-year period.
Contrary to what remodeling websites might suggest, you can’t expect to enjoy tax-free treatment on the profit or income gained immediately after buying and renovating a house for profit.
The IRS requires that you must have owned and used the property as your primary residence for a total of at least two out of the five years preceding the sale. The residency in the home does not need to be continuous. In other words, you could live there for a year, rent it out for three years, then move back in for a year, and still meet the requirement.
If you sold your primary residence in the two years leading up to the current sale date (and benefited from the tax exemption), you would no longer qualify for that tax-free benefit.
The same applies to secondary homes. It must have been your primary residence for two out of the five years.
However, under certain circumstances, this rule can be fully waived or at least partially waived.
One such case, as mentioned earlier, is in the event of a spouse’s death. Additionally, if you divorced and received the property in a divorce settlement, the time your ex-spouse lived in the home counts toward your residency.
If you fall ill, living in your home for only a year and spend another year in a licensed care facility, meeting the “two out of five years residency” rule can be waived.
Other temporary suspensions to the rule include:
– Military, intelligence, and Peace Corps personnel – may be exempt from the “two out of five years residency” rule when on eligible extended missions. This means you may meet the rule even if you weren’t physically present at home for at least two years.
– Unforeseen events – such as job changes that make it impossible for you to afford basic living expenses; your home is destroyed or taken by eminent domain; you give birth to twins or more in the same pregnancy; you qualify for unemployment benefits.
– Work-related circumstances – being transferred to a job location at least 50 miles farther than your current one. You have no job and start a new one 50 miles away from your current residence. Or one of these situations applies to your spouse or co-owner of the property.
Some of these circumstances may warrant full exemptions, while others may result in partial exemptions. It’s advisable to consult a tax professional to determine which category your situation falls into before filing your tax return.
Capital gains tax is based on the original cost of the property and the selling price. However, any improvements you’ve made to the property over the years will also be factored in.
Hence, it’s crucial to keep receipts for any renovations, new windows, driveways, HVAC systems, etc. These can help reduce your capital gain and potentially lower your tax burden.
You aim to earn as much income as possible from selling your home. However, if your income is high enough or your home’s value has appreciated significantly, you may end up owing taxes on your windfall.
Review your circumstances and retain your home renovation receipts. Most importantly, seek advice from a tax professional to understand your situation regarding capital gains.
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