When you sell real estate (also called real property), you have to report it to the IRS. If you made money from the sale, you'll report a gain; if you lost money on the sale, you'll report a loss. IRS Form 8949 (Sales and Other Dispositions of Capital Assets) is used to report your gain or loss, and you must also report it on Schedule D of your Form 1040. If you're able to exclude all of the gain as taxable income, however, you don't have to report the gain unless you receive a Form 1099-S (Proceeds from Real Estate Transactions).
Gains from the sale of real estate are reported on Form 8949 and on Schedule D to Form 1040. If you're able to exclude all your gain from taxation, you don't have to report the sale unless you received a Form 1099-S.
Real Estate Is a Capital Asset
"Capital assets" are generally any tangible property owned by the taxpayer, with some exceptions for certain business assets. Tangible assets are things you can touch; they are distinct from intangible assets, like accounts and intellectual property. Because of its nature as a tangible asset, your home is a capital asset. As a result, when you sell a home, the proceeds from the sale (the gains) are subject to capital gains tax rules.
How Capital Gains Work
"Capital gains" are the gains (profits) realized from the sale of a capital asset. Gains are calculated by taking the difference between your adjusted basis (what you paid for the asset with adjustments for certain expenses and deductions) and the amount you received from the sale. In simplified terms, if you paid $50,000 for your house and had no adjustments, your basis is $50,000; if you later sell the house for $80,000, your gain is $30,000.
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What Is the Basis of the Asset?
To calculate your capital gain or loss, you need to know the adjusted basis of the home. You start with the cost basis, which is the amount you paid for the home, and then make certain adjustments.
For example, if you pay past due taxes on a property when you buy it, those taxes you paid are added to your basis, i.e., if you pay $50,000 for a house and also pay $10,000 in back taxes, your cost basis is $50,000, but your adjusted basis is $60,000. Similarly, closing costs, such as transfer tax and fees for title insurance, can be added to the basis. If you later make improvements to the property, you can also add those expenses to your basis.
An increased basis means a reduced tax when you sell the asset. If you buy a house for $50,000 and pay $10,000 in property taxes for an adjusted basis of $60,000, and then make $25,000 in improvements, your adjusted basis grows to $85,000. If you then sell the property for $90,000, your taxable gain is $5,000.
Your basis can also decrease in certain situations. For example, if your home is damaged and you get an insurance payout or deduct the loss on your taxes, you need to decrease your basis by that amount. So if your adjusted basis starts at $85,000, but you receive a $10,000 insurance payout after a hail storm, your basis goes down to $75,000. If you then sell the home for $90,000, your taxable gain is $15,000.
Long-Term Gains vs. Short-Term Gains
Capital gains are subject to taxation, just like other income. However, the gains are taxed differently depending on whether they're long-term or short-term.
Long-term gains are gains on capital assets that you've owned for more than one year. If you buy a house and keep it for three years, any gains realized from the sale will be long-term gains.
Short-term gains are gains on capital assets that you've owned for one year or less. If you buy a house and then sell it six months later, your gains are short-term gains. Short-term capital gains can cost you far more in taxes.
Taxes on Short-Term Capital Gains
Short-term capital gains are taxed as ordinary income. The gains are added to your income from your job, and your tax is calculated based upon the marginal tax rates used for ordinary income. For the 2019 tax year, a single person will pay the following taxes on ordinary income:
- 10 percent on the first $9,700.
- 12 percent on the income between $9,700 and $39,475 (12 percent of $29,775).
- 22 percent on the income between $39,745 and $84,200 (22 percent of $44,725).
- 24 percent on the income between $84,200 and $160,725 ($76,525).
- 32 percent on the income between $160,725 and $204,100 ($43,375).
- 35 percent on the income between $204,100 and $510,300 ($306,200).
- 37 percent on any amounts above $510,300.
If you have a yearly salary of $100,000, your top tax bracket is 24 percent (you're taxed 10 percent on the first $9,700, 12 percent on the next $29,775, 22 percent on the next $44,725, and 24 percent on the remaining $15,800, for a total tax bill of $18,174.50).
However, if you realize an additional $75,000 in short-term capital gains, your tax bracket goes up to 32 percent, as your ordinary income will be $175,000, which is above $160,725. You'll be taxed 10 percent on the first $9,700 ($970 in tax), 12 percent on the next $29,775 ($3,573 in tax), 22 percent on the next $44,725 ($9,839.50 in tax), 24 percent on the next $76,525 ($19,131.25 in tax) and 32 percent on the remaining $14,275 ($4,568 in tax), for total income tax of $38,081.75.
Taxes on Long-Term Capital Gains
Long-term capital gains, on the other hand, are taxed at capital gains rates, which are lower than income tax rates. In 2019, a single person pays no tax on long-term capital gains of less than $39,375. For gains above $39,375 but less than $434,550, the tax is 15 percent and gains greater than $434,550 are taxed at 20 percent.
If you make $100,000 per year at your job and realize $75,000 in long-term capital gains instead of short-term, your tax is much lower. You'll pay the same $18,174.50 in taxes on your salary, but on the $75,000 capital gain, you'll be taxed zero percent on the first $39,375 and 15 percent of the remaining $35,625, which comes out to $5,343.75. Your total tax is down to $23,518.25, far less than the $38,081.75 you would pay if the gains had been short-term.
Gains and Losses on the Sale of Real Estate/Property
Real estate is a capital asset, so the sale of real estate creates a capital gain. Because real estate is such a high value asset, capital gains from the sale of real estate can create a huge tax bill, particularly if you sell the asset within one year of buying it. However, real estate sales are subject to certain exclusions for homeowners that can reduce or eliminate tax on the gain if they sell their principal residence.
Capital Gains Exclusions for Sale of Real Estate
Taxpayers who sell their main home may exclude $250,000 of the gains from taxation ($500,000 if you're married, filing jointly). If you bought your house for $200,000 ten years ago and sell it in 2019 for $500,000, you've realized a long-term capital gain of $300,000. If you're single, you can exclude $250,000 of that amount and pay tax on only $50,000. If you're married and you file jointly, you can exclude the entire $300,000 gain.
To qualify for the exclusion, you must have owned the home for two of the last five years. The home must be your residence and not a vacation property. Further, if you sold a home within the past two years and used the exclusion for that sale, you cannot use it again. A taxpayer may only use the exclusion once within a two-year period.
The rules may differ if you disposed of the property during a divorce or if you were widowed.
When Is Reporting a Home Sale Required?
There are two situations in which you must report the sale of your home to the IRS:
- You receive a Form 1099-S from the title company or any other entity involved in the transaction.
- You cannot exclude all the gains from the sale.
For instance, if you're single and you realize $300,000 on the sale of the home, you can exclude $250,000. Because you cannot exclude all the gains, you must report the sale to the IRS, even if you don't receive a Form 1099-S. However, if you're single and you realize only $200,000 on the sale of the home, you can exclude the entire gain, and you don't have to report the sale unless you're issued a 1099-S.
Receiving a Form 1099-S
If you receive a Form 1099-S, you must report the sale to the IRS regardless of your gain exclusion. You'll need to attach the form to your Form 1040, and you'll need to complete a Form 8949 and file it along with your return. You'll need to also report all the totals from the Form 8949 on Schedule D of your Form 1040.
Form 8949 will require you to list each property sold during the tax year along with the date you bought the property, the date you sold it, the amount of the proceeds, the amount you paid for the property, any adjustments to the gain or loss and the total gain or loss.
Adjustments to gain or loss are reported in Column F and Column G of the Form. Column F is where you report the type of adjustment, and Column G is where you report the amount of the adjustment, if any.
Form 8949 Codes
Form 8949 codes in Column F and G are for reporting adjustments to gains or losses on the sale of capital assets. Column F is where the codes are listed; Column G is for dollar amounts.
There are 16 codes available to use for adjustments to gains or losses. Those applicable to the sale of a home include:
- Code B, which you enter in Column F, if you received a Form 1099-B and it shows the incorrect basis. Your entry in Column G will depend on other factors.
- Code T, which you enter in Column F and also enter zero in Column G, if you received a Form 1099-B and the gain or loss shown is incorrect.
- Code N, which you enter in Column F and report the gain or loss in Column G, if you received a Form 1099-B or 1099-S as a nominee for the actual owner.
- Code H, which you enter in Column F and report the excludable gain as a negative number in Column G, if you're reporting the sale of your main home and can exclude some or all of the gain.
If you don't have any adjustments, you leave Columns F and G blank.
- IRS: Instructions for Form 8949 (2018)
- IRS: Topic Number 701 - Sale of Your Home
- IRS: Sale of Residence - Real Estate Tax Tips
- IRS: Publication 523 (2018), Selling Your Home
- IRS: Topic Number 409 - Capital Gains and Losses
- IRS: Capital Gains, Losses, and Sale of Home
- IRS: 2018 Instructions for Schedule D (2018)
- Cornell Law School Legal Information Institute: 26 U.S.C. Section 1221 - Capital Asset Defined
- The Tax Foundation: 2019 Tax Brackets
- IRS: Publication 551 (12/2018), Basis of Assets
- IRS: About Form 8949, Sales and other Dispositions of Capital Assets
- IRS: About Form 1040, U.S. Individual Income Tax Return
- NerdWallet.com: 2019-2020 Capital Gains Tax Rates - and How to Calculate Your Bill
- Finance.Zacks.com: How to Calculate Capital Gain on Selling a House