4 Things to Know About Capital Gains
A capital gain refers to a specific type of appreciation on a security, such as a stock or a home. These gains may or may not be taxed, depending on the circumstances of the home sale. Learn more about when and how they're used if you're planning to sell your home in the near future.
Capital Gains Are Taxed on a Progressive Scale
Taxation rates for capital gains are based on the seller's income. Any additional funds left from the home sale are tacked onto a seller's income and then taxed at the appropriate rates. Those in the lowest brackets are exempt from taxes, those in the middle brackets are taxed at 15 percent, and those at the upper end of the income brackets are taxed at 20 percent. Keep in mind that if the capital gain is large enough, it can push sellers from one income bracket to the next.
There Are Conditional Exclusions
Sellers may not have to pay capital gains if they've lived in their home for at least two years and sold it within five years of original purchase. In this case, each owner can exempt up to $250,00 worth of capital gains on the Clearwater Beach home. Typically, joint owners are spouses who can exclude up to $500,000. However, even if three friends chose to co-own a home together, they could potentially exclude up to $750,000 worth of capital gains.
Homes are allowed to be rented as long as the primary owners live in the home for at least two years. Please note years do not have to be consecutive, so long as the time all adds up in the end. To limit excessive flipping, sellers are not allowed to take advantage of this benefit more than once in two years.
Not All Appreciation Is a Capital Gain
Capital gains are the net profits a home seller receives from their home sale. So if a person buys the home at $75,000 and sells it for $100,000, it doesn't automatically qualify as a $25,000 capital gain. Sellers are allowed to deduct or add fees associated with the home purchase or sale. For example, a seller can deduct the closing costs paid for the home sale as well as the real estate agent fee.
If the seller paid closing costs on their original home purchase, they may be able to add those costs to the original $75,000 paid for the home. Sellers can even deduct major renovations (e.g., the addition of an additional bathroom) from capital gains. So even though the home sale may look like a capital gain initially, the final numbers may tell a different story. (Sellers do not have to pay taxes when breaking even or for a depreciated home value.)
A 1031 Exchange May Apply
A 1031 exchange may also allow the seller to avoid paying capital gains taxes at the time of the home sale. To qualify, sellers need to use all of their appreciation profits to buy a similar property. So if a sale goes through on a home for $1 million and the seller buys another home that costs $1 million, they may not have to pay a capital gains tax. A tax professional is usually a necessity if a seller chooses this option as it can be a complicated transaction. Please note that a 1031 exchange typically only defers the taxes until the next sale rather than exempting the seller entirely.