Selling your home is an exciting milestone, whether your next step is downsizing, relocating, or moving into your dream house. However, before you celebrate the sale, it's important to understand how capital gains taxes could affect your proceeds. While many homeowners qualify for valuable tax exclusions that can significantly reduce—or even eliminate—the tax they owe, the rules can be more complex than they appear. Here's what you need to know about how capital gains are calculated, the exclusions that may apply, and strategies that could help you keep more of your hard-earned profit.

Understanding capital gains

Capital gains tax is a type of tax on profits earned from the sale of assets like stock or real estate. When these are sold for more than they cost to purchase, the IRS taxes the gain. In real estate, capital gains are calculated by taking the final total sale price of the house and deducting its original cost. However, the tax on that gain is calculated with additional considerations:

• How long you owned the house
• Any fees you've paid—escrow, recording and appraisal fees, brokers' commissions
• Your income tax bracket
• Your marital status

If you've owned your house for less than a year, then the capital gains are considered short term. In this case, taxes are paid at the same rate you'd pay for ordinary income (such as wages from your job). If you owned your home for more than a year, the capital gains are considered long term. The rates for long-term capital gains are 0%, 15%, or 20%. The rate you pay is dependent upon on your income level, though all are typically lower than ordinary income tax rates. There may also be local taxes depending on your state.

Exclusions

It's likely that you've owned your home for more than a year, so you will likely be subject to long-term capital gains rates. However, you may be able to avoid some of the tax because real estate gains are subject to different rules than investment capital gains. These rules apply only to your primary residence, though; if the home you sold was a second property—such as an investment, vacation, or rental home—and you never converted it to your primary property, you are not eligible for capital gains tax exclusions.

For most of the following exemptions, you will need to have owned and lived in the house for two of the five years preceding the sale:

• You might be able to defer capital gains if, after you sell your property, you apply your profits to the purchase of a new property within 180 days.
• You might be able to take advantage of a capital gains tax exclusion that applies to your primary residence once every two years. Exemptions are $250,000 if single and $500,000 for couples filing jointly (though, some widowed individuals may be eligible for the $500,000 exemption).
• Itemized construction expenses can be added to the cost basis of your house, thereby helping decrease your tax liability. Improvements must be considered major—adding a new bedroom, renovating a kitchen or bathroom, installing a roof—and must be documented; estimates won't work. For examples of other home improvements, see IRS Publication 523, Selling Your Home.
• Selling costs, such as real estate agent fees and closing costs, can be deducted from the sale proceeds to reduce your capital gain.
• You might qualify for a partial exclusion if you sold your home as the result of an unforeseen circumstance—for example, if you moved for work, had a health complication, faced divorce or marital separation, suffered the death of your spouse, or incurred a loss from a natural disaster. You may also qualify for a partial exclusion if you came to serve in the uniformed, foreign, or intelligence services.

Also, genuine home improvements (as opposed to mere repairs) can raise the basis, saving you money at sale time if you're reaching the $250K/$500K threshold. 

We’re here to help

You may be like many homeowners who've experienced significant capital gains since you purchased your home, but you can manage the tax liability and keep more of the profit in your pocket. If you have questions about the tax implications of selling your home, please contact us using the form on this page.

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