By the end of this post, you will understand the house sales tax!
There are many reasons why you may want to sell your home:
- You may want to take profits and run.
- You may need to upsize or downsize.
- Or maybe you just don’t want to deal with owning a house any longer.
Whatever the reason is when selling your house, one thing you want to take into consideration is your potential house sales tax liability.
Now understanding and navigating your way around taxes can be a daunting task if you are not a CPA or Uncle Sam himself.
But we’ve done the work for you and there is value for everyone.
We’ve broken our research up into the following categories:
- People looking to sell their primary residence.
- Those looking to sell their investment property.
- And lastly, those who are looking to sell their fix and flip project.
We even included legal loopholes to help you avoid paying taxes on the sale of your home so you definitely want to read this whole article.
Let’s start with the first category, your primary residence.
House Sales Tax Category #1: Primary Residence
When selling your primary residence, most people won’t pay any taxes at all.
That’s because according to the Section 121 exclusion from the IRS, you won’t need to pay taxes on up to $250,000 of net profit.
Or, up to $500,000 if filing jointly if you meet 3 basic requirements:
- You owned the house for at least 2 years.
- The house was your primary residence for at least 2 full years.
- You waited at least 2 full years before using the $250,000/$500,000 tax benefit on another primary house.
Any leftover profit that exceeds $250,000 if filing single, or up to $500,000 if filing jointly, is taxed at a rate of 0%, 15%, or 20% depending on your income.
Here’s a look at the bracket.
Please note, according to the IRS, you must report the sale if:
- You choose not to claim the exclusion OR
- You receive Form 1099-S (proceeds from real estate transactions)
If you don’t qualify for the capital gains tax exclusion, you may qualify for a reduced exclusion if “the living conditions of a qualified individual change,”
A qualified individual in this scenario would be the following people:
- your spouse
- a co-owner
- a resident
And the reasons one may qualify for and claim a reduced exclusion include the following:
1. You moved for a new job and:
- that new job is at least 50 miles farther from your new house than your previous job (or, if you didn’t have a previous employer, at least 50 miles farther from your previous home) and
- you changed your employment situation while you still owned and lived in the house.
2. Your qualified family member living in your house has a disease, illness or injury and you have to sell your property to:
- get them a diagnosis, a cure, mitigation or treatment or
- because a doctor recommends a change of residence for medical or personal care reasons.
3. You experience unforeseen personal, familial or environmental circumstances such as:
- becoming eligible for unemployment compensation
- being unable to pay for basic living expenses
- employment changes
- involuntary conversions, such as your house being destroyed, condemned or under threat of
- multiple births from the same pregnancy (twins or triplets)
- natural or man-made disasters
Quick Note: You cannot deduct a loss from the sale of your primary home on your taxes.
House Sales Tax Category #2: Rental Property
If you own a rental property and intend to sell, gains from that sale will be taxed at the capital gains tax rate depending on how long you’ve held the property.
If your rental property was held for less than a year, you will be subject to the short-term capital gains tax.
The short-term capital gains are taxed at the same rate as your regular income.
If your rental property was held for more than a year, you will be subject to long-term capital gains tax. Let’s take a look at the long term capital gains tax rate for 2020:
You will want to check the current year’s capital gains tax rate to see where your tax liability falls.
Another thing to know regarding taxation on rental properties is that you will be taxed for depreciation recapture.
Smart investors write off depreciation as an “expense” to reduce their yearly tax burden.
And when you sell your rental home, you will be taxed on that depreciation, whether you took the depreciation deduction or not. So, you might as well take it!
The key here is to be sure to include depreciation in your cost basis when you sell. We’ll talk a bit more about that later in the post.
Now, let’s talk about how you save on taxes when selling a rental home!
How to Save on Taxes When Selling Rental Properties
Here are three legal loopholes to minimize your tax hit:
1. 1031 Exchange
Here are three things to keep in mind regarding a 1031 exchange.
a. A 1031 like-kind exchange is a real estate investor favorite that allows you to sell one property and use the proceeds of the sale to acquire a new property.
All while deferring taxes until a sale is made on the new property, if at all.
b. With a 1031 Exchange, any cash left over after purchasing the “like-kind” property is considered a taxable capital gain.
c. While a wonderful strategy, note that the process is not simple, the rules are strict, and we’d recommend studying up on the rules.
Or, hiring a professional to help conduct the exchange for you as the tax penalties for failing to do a 1031 exchange properly can be costly.
2. Tax Loss Harvesting
Tax loss harvesting is the act of selling a losing investment to offset capital gains.
As it stands, the IRS currently allows you to use capital losses to offset an unlimited amount of capital gains.
As with most things concerning taxes, there are stipulations, so consult with your CPA to make sure you perform tax loss harvesting properly.
3. Converting the property to your primary residence
Why? Remember that you’re able to exclude up to $250,000 worth of profit if you’re a single filer and $500,000 if you’re married filing jointly when you sell your primary residence.
Because of this, many investors resort to converting their rental property into their primary residence to help them take this benefit.
Note that when taking this approach, you must have maintained the residence as your primary residence for at least two of the last five years.
And, a percentage of gains will still be taxable based on how many years the property served as a rental.
House Sales Tax Category #3: Fix and Flip
In general, a flipper is categorized by the IRS as a “dealer,” and the profits from a sale will be taxed at your ordinary income tax rate.
But, if the flipped property was held for more than a year, you will be subject to long-term capital gains tax.
Here’s another look at the long term capital gains tax rate for 2020:
In addition, flippers must pay double FICA taxes (Social Security, Medicare, and Medicaid taxes) in addition to any state and local taxes.
How To Calculate Your Gain or Loss From the Sale of Real Estate
The Formula is: Sales Price – Cost Basis = Gain
– Sales Price is the amount you sold it for
– Your Gain is the amount you profited
But most people scratch their head when it comes to your “cost basis”. Here’s how you determine it:
Original cost of asset
Improvements to asset
Repair of damages to asset
Depreciation to asset
Deducted casualty loss to asset
Adjusted basis of asset
You’ve made it to the end of the post!
By now, whether you are selling your primary residence, a rental property, or a fix and flip, you should have a pretty good understanding of your possible tax liability.
Please remember that everyone’s tax situation is different and it is strongly advised to consult your CPA if you have one.
Or, consider hiring a CPA from LYFE Accounting to help you save and remain compliant with the IRS. Talk to us today!