Capital gains tax can happen when a homeowner buys their home for $100,000 and then, later on, sells their home for $500,000. Unfortunately, the seller may have to pay taxes on those profits in the form of capital gains tax. Now, with the new Tax Cuts and Jobs Act changing some rules, now is a great time to go over capital gains and how they work.
The first thing to mention would be the requirements to claim an exclusion of up to $500,000. The home your selling must be your primary residence, you must have owned the house for at least two years, and you must have lived in the house for at least two of the last five years. If those requirements are not met, you may be able to take a partial exclusion for capital gains. However, something to keep in mind is that the IRS gives each person a $250,000 tax-free exemption for a primary residence; no matter the sellers' earnings.
Now let's go over how much the seller would have to pay for the capital gains tax. In the past, the government would take out some of the sale based on the sellers' tax bracket. However, under the new tax law, the capital gains rate is now based on the seller's income. If the seller is single and earns less than $39,375 a year or if the sellers are married filing jointly while earning less than $78,750 they will pay 0 percent in capital gains. If the seller earns between $39,376 and $434,550 or the sellers make $78,751 to $488,850 they will have to pay 15 percent in capital gains. However, the rates top out at 20 percent, so a seller who makes more than $434,550 or sellers who make more than $488,850 will pay 20 percent in capital gains.
However, there is one way to reduce the capital gains tax. Home improvements or renovations can reduce the amount you pay. For example, if a seller bought their home for $100,000 and then wants to sell their home, years later, for $450,000. However, let us say they spent $100,000 in renovations (new roof, flooring, or electrical wiring for example) would be subtracted from the sales price. So instead of owing capital gains on $350,000, the seller would owe on $250,000. Which means the seller would be excluded from the capital gains tax and owe nothing.
Things do get more complicated for real estate investors. If the home being sold isn't the primary home for the seller, capital gains tax can be more difficult to exclude. The best way to avoid capital gains tax would be to do a 1031 exchange. This would allow the seller to sell their property and buy another one without recognizing any potential gain.
Whether you’re a buyer, seller, or agent, SETCO is here for you. SETCO Services spans beyond great title insurance, escrow, and real estate closing assistance. We are here for you if you need information about our service or if you’re ready to get quality closing services.