The capital gains tax is one of the most misunderstood parts of our tax codes today. Many potential home sellers are terrified that the IRS will claim a huge chunk of their profits from the sale of their home; others are oblivious to it and get surprised by a huge unexpected tax bill the following April after they sell their home.
While the capital gains tax should not be ignored, the truth in practice is that most home sellers end up having to pay very little, or no tax at all — especially if they are aware of the timing and exemptions. While we are not tax experts (and you should not consider the following as tax advice), let’s demystify this topic a little and talk about how capital gains works in general when you’re selling your home.
Capital Gains Tax Basics
Essentially, when you make a profit off the sale of your home, the IRS considers this to be taxable income even though it is not officially “wages.” Thus, any amount that exists after deducting your costs (including commissions, closing costs, property taxes, cost of home improvements, etc.) is considered profit and will theoretically be taxed at rates comparable to your other taxable income.
That said, the government offers a huge exception to this rule that enables a great many qualifying homeowners to claim an exemption to the capital gains tax and allows them to walk away with all the profit, tax free. The exemption also works in a way that those who do have to pay tax will often not have to pay the entire amount.
How the Capital Gains Exemption Works
Capital gains is primarily meant to target investors who make a living off real estate, not to bite homeowners, per se. Thus, the exemption is designed to benefit property owners who actually take up residence in their home. The rule basically exempts a single homeowner from capital gains tax for the first $250,000 of profit; for a married couple, that number is $500,000. As you can see, most resident homeowners fall easily into this category; unless you bought your 5-bedroom home with your spouse in 1967 and are selling it at current market rates, you probably will not make a $500,000 profit off your home — and if you do, you will only pay capital gains on the amount you earn over that $500,000 threshold.
To qualify for the exemption, homeowners must have the following:
- Own the home for a minimum of two years
- Lived in the home for at least two of the last five years
- Have not claimed the exemption within the past two years
Other Considerations
What if you live in your house less than two years but are forced to sell due to a life change, health issues, job relocation or some other circumstance? Never fear — the capital gains tax rule can still help you claim at least some of your exemption.
If you sell your home within the two-year threshold due to a job change, health issues or other situations which the IRS deems as “unforeseen circumstances,” you may be able to prorate the amount of the exemption based on the number of months you lived in the home. For example, if you are a single taxpayer who bought a home, then got transferred out of state 18 months later due to your job, you can still claim 18/24 of the exempted amount, or $187,500 of the original $250,000. Even if your home value went up $100,000 during the 18 months you lived there, you would still be well within the threshold of the exemption.
When Do You Pay Capital Gains Tax?
If you do owe some money in capital gains tax, you will likely receive a 1099-b or 1099-DIV with your closing documents stating how much you made on the sale of your home. Bring this document to your accountant or tax preparer to determine how much tax you will owe on this income. Many tax professionals recommend paying this tax by the following quarterly due date for estimated taxes after the sale of your home; however, talk to your tax expert for more specific advice.
To summarize, you should be aware of capital gains taxes, but not necessarily afraid of them, especially if you are a homeowner living in your home. When you are ready to list your Atlanta home for sale, call Atlanta Fine Homes Sotheby’s International Realty at 404.948.4812.