What Home Sellers Need to Know About Capital Gains Tax
As you get ready to sell your home, it’s exciting to see that your home has increased in value, allowing you to collect a tidy profit once you finalize the sale. Naturally, you might be getting a bit worried about how much you’ll have to pay in taxes, though.
Capital gains are the profits you receive any time you buy something at one price and sell it for a higher price. The two times that most people have to worry about capital gains are when they sell investments and when they sell their home.
While it sounds a little scary to think about paying taxes on your capital gains, it’s not as hard as you might think. Even better, you may not have to pay any taxes on that profit!
Learn more about what to expect.
The “Inclusion Rate”
Capital gains are an advantageous way to increase income because you’re not required to include the full amount of the gains as income. As of 2019, the inclusion rate is 50 percent. This means that if you had $100,000 in capital gains, you’d only have to pay tax on $50,000.
This is a contrast to other types of investment income. For instance, if you received dividends from owning stock or income from an investment property, you’d have to include 100 percent of that money as income.
Different Rules for Principal Residences
As we mentioned, you can have capital gains from a variety of investments, but the good news is that there are special rules when it comes to gains that come from the sale of a principal residence. What does principal residence mean? It means that you’ve lived in the home for two of the past five years. If that’s the case for you -— and it’s the case for most people selling their homes — then you qualify to have up to $250,000 of those capital gains remain tax-free. If you’re married, you can have up to $500,000 tax-free.
Remember, this is only the profit you make, not the sale price of the home. So, if you paid $400,000 for your home, and you’re now selling it for $500,000, you only have $100,000 in capital gains, and you wouldn’t need to pay tax on it. We’ll get into some of the details of how you calculate purchase price and sale price in a bit, but for now, we wanted to use nice round numbers.
Short-Term vs. Long-Term Capital Gains
The 50 percent inclusion rate only applies to “long-term” capital gains, meaning gains from investments you’ve held on to for at least a year. If you’ve had the investment for less than a year, you need to include 100 percent of the capital gains in your income.
This rule rarely applies to people who are selling a primary residence. Most of the time, people will stay in their homes several years before they think about selling. And if for some reason, you did have to sell a home less than a year after you bought it, there’s a good chance that you won’t make a significant profit off of it. Most likely, any increase in value will be eaten up by the fees associated with selling the home.
Profit Might Not Be What You Think
We have more good news. You get to include the taxes and fees associated with your original purchase and any improvements you’ve made to the home into the cost of the home. This effectively decreases the amount of capital gains you’d have, so you pay less in taxes, if you have to pay any taxes at all.
For instance, let’s say the original cost of your home was $325,000. You paid $10,000 in taxes and fees when you bought the house, and you paid $50,000 in some upgrades and renovations. When calculating your capital gains, then, your “original price” would be $385,000. If you’re able to sell the home for $550,000, your capital gains are $165,000, not the $225,000 you might have thought if you were calculating from the purchase price of your home alone.
Offsetting Capital Gains
With the allowances made for those who are selling a principal residence, we see that the capital gains tax is not a big concern for most people selling their homes. However, if your gains will exceed the limits, you may be able to offset those gains by selling off some underperforming stock investments.
Even though you may not need to pay any tax on the capital gains from the sale of your home, you should still report it when filing taxes. Since the home sale can add a layer of complications to the year’s return, we suggest hiring a tax professional to help you that year.