Many longtime homeowners have seen their modest family houses transform into unexpected gold mines. The modest abode they bought decades ago might have doubled—or even tripled—in value, promising a comfortable cushion for retirement. But when they move to sell, that joy can quickly fade to shock when their accountant delivers the bad news: A slice of that hard-earned profit is headed straight to the IRS.
Years of soaring home prices have turned ordinary homeowners into accidental millionaires—and, in many cases, unexpected taxpayers. What used to be a concern only for the ultrawealthy or lifelong owners now reaches far more everyday sellers than ever before. Nearly 8% of all U.S. home sales last year netted more than $500,000 in profit—a sixfold jump from two decades ago.
So, what exactly is a capital gains tax? Why is this once-rare tax bill landing on more kitchen tables these days? And, most importantly, how can you keep more of your profit when you sell? Here’s what every homeowner should know before planting that "For Sale" sign in the yard.
Home sale capital gains 101: Understanding the exclusion
The capital gains tax is levied on the profit you make when you sell an asset, like stocks, real estate, or a business. But for homeowners, special rules have long shielded everyday sellers from owing tax on the sale of their primary home—at least up to a point.
When you sell your primary home, the IRS lets you protect a big chunk of your profit from capital gains taxes. Single homeowners can exclude up to $250,000 of profit from taxes, while married couples filing jointly can exclude up to $500,000. If your profit stays below these limits, you won’t owe a penny of federal capital gains tax on your home sale.
Who qualifies?
To claim the full exemption, you must meet three basic rules:
- Ownership:You must have owned the home for at least two of the past five years.
- Use:You must have lived in it as your main residence for at least two of the past five years.
- Timing: You can’t have used this exclusion for another home sale within the past two years.
These requirements prevent people from flipping multiple properties tax-free and are designed to help long-term homeowners keep more of their equity.
Why more sellers are facing capital gains taxes now
Skyrocketing prices, same old tax limits. The $250,000/$500,000 capital gains exclusion was set in 1997 and hasn’t budged since. Meanwhile, U.S. home prices have soared, especially in the past decade.
For context, the national median home price roughly doubled from 2012 to 2022. If you adjust for inflation, a $500,000 exemption set in 1997 would be worth over $1 million today. But the law never changed, so the cap still sits at a half-million dollars. That means today’s homeowners, especially in hot markets, hit the limit far more easily than sellers did 20 or 30 years ago.
How capital gains tax on a home sale is calculated
To calculate your own gain, start with this simple formula: capital gain = selling price − (purchase price + improvements/expenses)
Your eligible costs, also known as your cost basis, include what you paid for the home plus any major improvements and certain selling expenses. This can include remodeling a kitchen, adding a room, installing a new roof, or putting in a pool. Selling expenses like real estate agent commissions and some closing costs count, too.
Once you know your profit, you subtract the allowed exclusion: $250,000 for single filers or $500,000 for married couples filing jointly. If your profit stays below that threshold, you’re in the clear for federal capital gains tax. If it’s over, only the amount above the limit gets taxed.
Short-term vs. long-term
Most homeowners selling a primary residence after living there for years will have long-term capital gains, taxed at a special lower rate between 0% and 20%. (Higher-income households might pay 20%, and the lowest-income homeowners could pay 0%, but that’s rare for large home-sale profits.)
If you sell a home you’ve owned for one year or less, any profit is considered short-term and gets taxed at your ordinary income rate, which is usually higher.
Will you owe capital gains tax?
These examples show how the rules work in real life, so you can gauge if you might owe anything.
Example 1: Move-up buyer in a hot market
A single homeowner bought a starter home for $200,000 10 years ago. They’ve put in $50,000 of upgrades over the years. It’s now worth $500,000.
- Purchase price:$200,000
- Improvements:$50,000 (new bathroom, updated kitchen)
- Selling price:$500,000
Capital gain = $500,000 − ($200,000 + $50,000) = $250,000
As a single filer, they can exclude up to $250,000, so they’d owe zero in capital gains tax.
If the sale price were slightly higher, say $520,000, the gain would be $520,000 − $250,000 = $270,000. They could exclude $250,000, but $20,000 would be taxable at their capital gains rate.
Example 2: Longtime owners downsizing
A married couple bought a home decades ago for $100,000 and invested $100,000 in renovations. Now they’re selling in a hot market for $800,000.
- Purchase price: $100,000
- Improvements: $100,000 (additions, new roof)
- Selling price: $800,000
Capital gain = $800,000 − ($100,000 + $100,000) = $600,000
A married couple filing jointly can exclude up to $500,000, leaving $100,000 taxable. At a typical 15% long-term capital gains rate, they’d owe about $15,000 in federal capital gains tax.
Example 3: Selling sooner than expected
A young family buys a home for $400,000 but has to move after just 18 months due to a job transfer. They sell for $500,000, a $100,000 gain.
- Purchase price: $400,000
- Improvements: None
- Selling price: $500,000
Capital gain = $500,000 − $400,000 = $100,000
They owned the home for only 18 months, so they don’t qualify for the full exclusion. But since the move was due to a job transfer, they can claim a partial exclusion. They lived there for 75% of the required time (18 months out of 24), so they can exclude 75% of $500,000, which is $375,000.
Their $100,000 gain is under the partial limit ($375,000), so they’d owe zero capital gains tax.
Tips to minimize or avoid a big tax hit
If you think your profit might push you over the federal exclusion, there are ways to soften or even avoid a big tax bill.
- Increase your cost basis: Keep every receipt for home improvements. Renovations, additions, new systems, all these can boost your cost basis and lower your taxable gain. Don’t forget to factor in real estate agent commissions and some closing costs, too.
- Time your sale wisely: If you’re close to the two-year mark, hang on if possible to lock in the full exclusion. Staying over one year also ensures your profit is taxed at the lower long-term capital gains rate.
- Maximize the married exemption: If you’re married, both spouses must meet the use test to claim the full $500,000. After a spouse’s death, the surviving spouse may still claim the full amount for up to two years.
- Consider staying put:Some older homeowners choose to keep their home and pass it to heirs, who get a “step-up in basis.” This means your kids inherit the home at its current value, wiping out past capital gains. While it's not for everyone, it’s an important factor to consider when estate planning.
- Talk to a pro: If your profit is likely to exceed the limit, or if you have unique circumstances (like rental use or a previous exclusion), a tax adviser can help you find ways to save or plan ahead.
Allaire Conte is a senior advice writer covering real estate and personal finance trends. She previously served as deputy editor of home services at CNN Underscored Money and was a lead writer at Orchard, where she simplified complex real estate topics for everyday readers. She holds an MFA in Nonfiction Writing from Columbia University and a BFA in Writing, Literature, and Publishing from Emerson College. When she’s not writing about homeownership hurdles and housing market shifts, she’s biking around Brooklyn or baking cakes for her friends.
Source: realtor.com
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