Capital Gains Taxes on a Primary Residence vs. Investment Residency

Thinking through all the different taxes associated with home ownership is definitely one of the least exciting parts of owning or selling a house. It’s much more thrilling to think about how you’ll spend the potential money you’ll make once the sale is finalized or where you’re moving to next. However, understanding capital gains taxes and how they could impact your sale will prove to be beneficial.

What are Capital Gains?

Capital gains are taxes paid on the sale of an asset or property that has increased in value since the time you originally purchased it. For example, if you purchased your home for $200,000 and sold it for $230,000, your capital gain (profit) would be $30,000. The $30,000 is then subject to being taxed.

How are Capital Gains Rates Determined?

If you’re single and sell your primary residence you’re exempt from capital gains taxes on the first $250,000. If you’re married and file jointly, you’re exempt from the first $500,000 gained on the sale.

In the United States capital gains only apply to assets that have been owned for more than a year. These are known as “long-term capital gains.” The rates are 0%, 15%, or 20%, based on your tax bracket. Assets that have been held for less than a year, or “short term gains,” are taxed as regular income.

Capital Gains Exemptions

In order to be exempt from capital gains taxes, the home must be considered a primary residency based on the rules laid out in the IRS. The home must have been occupied by the owner for at least two out of the last five years in order to be considered a primary residence. If you purchase a home and suddenly see there is a significant rise in capital gain and decide to sell, you’d be required to pay capital gains tax on that property. Gains on second homes or non-primary residences do not qualify for the same exemptions.

Note that the two year residency rule laid out by the IRS doesn’t require the two years to be consecutive. Which is good news for anyone wanting to turn a rental or investment property into a primary residence when selling. Homeowners should also be aware that sellers can only benefit from this exemption once every two years. In order to avoid high capital gains taxes, taxpayers can offset their gains with capital losses in order to lower the taxes owed (track your expenses and keep receipts!) — which is especially important for those who buy, flip and sell homes often.

What is a 1031 Exchange?

A 1031 Exchange allows a property owner a unique way to offset capital gains taxes by allowing a seller to take the profit from one sale and invest it in the purchase of another similar property. This type of transaction, or exchange, doesn’t completely eliminate the tax, but rather deferrs it. Keep in mind, the exchange must be toward an investment property or business and not toward a primary residence to be considered valid. Some sellers will find themselves unable to qualify for an exemption and choose what is known as an installment sale, which allows for part of the capital gain to be deferred over a period of time.

Real estate taxation can be tricky, but having a basic understanding will allow any seller to enter into a transaction with the ability to make educated decisions. A qualified real estate agent can also help navigate the twists and turns associated with real estate. Contact Misty Morrison to assist you in your next real estate transaction today. Call 321-209-1523.

Misty A. Morrison
‪321-574-8119‬ (mobile)