The money you make on the sale of your home might be taxable. Here's how it works and how to avoid a big tax bill.
It feels great to get a high price for the sale of your home, but watch out: The IRS may want a piece of the action. That’s because capital gains on real estate are taxable sometimes. Here’s how you can minimize or even avoid a tax bite on the sale of your house.
The IRS typically allows you to exclude up to:
For example, if you bought a home 10 years ago for $200,000 and sold it today for $800,000, you’d make $600,000. If you’re married and filing jointly, $500,000 of that gain might not be subject to the capital gains tax (but $100,000 of the gain could be).
Your $250,000 or $500,000 exclusion typically goes out the window, which means you pay tax on the whole gain, if any of these factors are true:
If it turns out that all or part of the money you made on the sale of your house is taxable, you need to figure out what capital gains tax rate applies.
Short-term capital gains tax rates typically apply if you owned the asset for less than a year. The rate is equal to your ordinary income tax rate, also known as your tax bracket. (What tax bracket am I in?)
Long-term capital gains tax rates typically apply if you owned the asset for more than a year. The rates are much less onerous; many people qualify for a 0% tax rate. Everybody else pays either 15% or 20%. It depends on your filing status and income.
Live in the house for at least two years. The two years don’t need to be consecutive, but house-flippers should beware. If you sell a house that you didn’t live in for at least two years, the gains can be taxable. Selling in less than a year is especially expensive because you could be subject to the short-term capital gains tax, which is higher than long-term capital gains tax.
See whether you qualify for an exception. If you have a taxable gain on the sale of your home, you might still be able to exclude some of it if you sold the house because of work, health or “an unforeseeable event,” according to the IRS. Check IRS Publication 523 for details.
Keep the receipts for your home improvements. “The cost basis of your home not only includes what you paid to purchase it, but all of the improvements you've made over the years,” says Steven Weil, an enrolled agent and president at RMS Accounting in Fort Lauderdale, Florida. When your cost basis is higher, your exposure to the capital gains tax is lower. Remodels, expansions, new windows, landscaping, fences, new driveways, air conditioning installs — they’re all examples of things that can cut your capital gains tax, he says.
Article originally appeared on NerdWallet. About the author: Tina Orem is NerdWallet's authority on taxes. Her work has appeared in a variety of local and national outlets.