Selling a home is a major financial decision that can have a big impact on your personal assets, monthly expenses and taxes, especially if you are an inexperienced first time home seller. When you sell property that has increased in value, you make a profit. Profits on capital assets are called capital gains, and they are usually subject to federal taxes.
Tax Breaks for Home Sellers
In some situations, you will owe tax on the sale of real estate. Fortunately, the government offers a special tax break for home sellers, for gains made on the sale of a home used as your residence.
If you sell a home that you have used as your primary residence, you will likely qualify for valuable tax breaks on the proceeds from the sale. However, it is worth noting that the huge tax break for home sellers is not just exclusive to first-time sellers.
Keep in mind that people who have sold homes in the past face additional requirements to qualify. However, they can use them afterward, repeatedly, as long as the conditions are met.
Reduced Capital Gains for Residences
A capital gain is the difference between the amount you get when you sell an asset and its original cost. Capital gains are a form of taxable income, but gains you make on property you hold longer than a year – also called long-term gains – are generally taxed at lower rates than ordinary income.
If certain criteria are met, the IRS offers a tax exclusion of $250,000 on capital gains you make when selling a home. In other words, if you qualify, $250,000 of those profits will not be taxed. If you are married and file a joint tax return, you may be able to exclude up to $500,000 of gains from taxation.
You have to meet two basic requirements known as the ownership and use tests to exclude home sale gains. To satisfy the ownership test, you must have owned the home for two of the past five years and to pass the use test, you need to have lived in the home as your main residence for two of the past five years. If you plan to exclude $500,000 as a joint filer, you and your spouse must both meet the use test.
Exceptions for More Than One Sale
A first-time home seller that meets the ownership and use tests can use the home sale exclusion. And then, they can reduce their capital gains on a first home sale.
The same cannot be said for people who have sold other homes in the past. You can't avoid capital gains tax on a house sale if you excluded the gain on the sale of a different home within the past two years.
In the case of joint filers, the $500,000 exclusion is only available if neither spouse excluded gains on the sale of a different home within the past two years.
2021 Capital Gains Percentages
For the 2021 tax year, the long-term capital gains tax rate is 0 percent if you make up to $40,400 per year for single filers and double that for married people filing joint returns.
The 15 percent rate applies if you make over $40,400 per year up to $445,850 per year if filing as a single. For married couples filing jointly and qualifying widows or widowers, the upper threshold is $501,600. In addition, heads of households will pay the same rate if they have an income of between $54,100 and $473,750. Also, married people filing separate returns have a much lower upper threshold of $250,800.
The 20 percent rate applies to incomes exceeding the upper thresholds set for the 15 percent rate.
On the other hand, short-term capital gains are taxed as ordinary income. If you sell a home at a price that is less than what you paid, you have a capital loss, which is not taxable.
Read More: Deducting Mortgage Interest on a Second Home
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.