Real Estate Capital Gains Tax: A Complete Guide [2021]

Key Takeaways


It’s tax season, and it’s to your advantage to know about the taxes and deductions that apply to you. Capital gains tax on real estate is something you definitely want to be familiar with if you own any real estate, whether it’s your home or another type of investment property. This is especially true if you recently sold, or plan to sell, your property, which is when capital gains tax goes into effect. This guide will break down how real estate capital gains tax works, different nuances to be aware of, and how to minimize the tax as much as possible if you’re subject to it.

What Is Capital Gains Tax On Real Estate?

The name says it all: a tax levied on any gains made from a real estate sale. To clarify, capital gains are only realized when an asset is sold for more than it is purchased. Therefore, you may not be taxed on capital gains if you sell a property for less than you bought it for.

What Are Capital Gains Tax Rates?

If you were to sell a property, the capital gains tax you would owe depends on three main factors: how long the property was in your name, your income, and your tax filing status.

Based on your income bracket and filing status, the capital gains tax rate on real estate is either 0%, 15%, or 20%. The majority of Americans fall into the lowest couple of income brackets, which are assessed 0% in capital gains tax. However, note that these tax rates only apply if you’ve owned your property for more than one year. If you’re selling the property in under one year, then you’ll be subject to an entirely different tax structure. In a moment, we’ll explain the difference between short-term vs. long-term capital gains tax.


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Capital gains tax rate real estate

How To Calculate Capital Gains Tax

If you’re unfamiliar with capital gains, here are some basics you should know.

Capital gains are simply the profit you make when selling an asset, such as stocks, real estate, and other investments. Here is what the simply formula looks like:

Capital Gains = Selling Price – Original Purchase Price

The IRS (Internal Revenue Service) taxes investors on these capital gains, thus the name “capital gains tax.” Any time you make income from employment, the government will take a cut. Any income earned from selling assets is no different.

You may be wondering if you will owe any taxes if an asset you own, whether it be real estate or stocks, increases in value. The answer is no. You will only owe capital gains tax when your gains are realized, which means you’ve sold the asset and pocketed the cash.

Long-Term Vs. Short-Term Capital Gains Tax

The capital gains tax structure varies significantly, depending on whether your real estate investment was short-term or long-term.

If you’ve owned a property and sold it after less than one year, then you’ll be subject to the short-term capital gains tax rate. The rate is the same as the income tax rate based on your income bracket. This is pretty steep, so the incentive to buy and hold onto your property is pretty strong.

If you’ve owned a property and sold it after a year or longer, then you fall into the long-term capital gains tax rate category. Remember, the long-term capital gains tax rates are 0%, 15%, or 20%, depending on your income and filing status. We’ve broken down the tax rate by income bracket in the next section.

Capital Gains Tax Rates

If you are filing your taxes as a single person, your capital gains tax rates are as follows:

  • 0% if your income was between $0 and $40,000.

  • 15% if your income was between $40,001 and $441,450.

  • 20% if your income was $441,451 or more.

If you are filing your taxes as married, filing jointly, your capital gains tax rates are as follows:

  • 0% if your income was between $0 and $80,000.

  • 15% if your income was between $80,001 and $496,600.

  • 20% if your income was $496,601 or more.

If you are filing your taxes as the head of household, your capital gains tax rates are as follows:

  • 0% if your income was between $0 and $53,600.

  • 15% if your income was between $53,601 and $469,050.

  • 20% if your income was $469,051 or more.

Last but not least, if you are filing your taxes as married, but filing separately, then your capital gains tax rates are as follows:

  • 0% if your income was between $0 and $40,000.

  • 15% if your income was between $40,001 and $248,300.

  • 20% if your income was $248,301 or more.

Capital Gains Tax Example

There’s nothing better than an example to help pull all of these concepts together.

Let’s say that you are an individual who is filing single this year. Your annual salary is $65,000, which puts you at a tax rate of 22%. You just sold your first home for $15,000 more than the original purchase price. (You got a promotion and are moving to your company’s headquarters in a different city.)

If you owned the home for less than one year, then you’d be subject to short-term capital gains tax. If you recall, the short-term capital gains tax rate is the same as your income tax rate. At 22%, your capital gains tax on this real estate sale would be $3,300. ($15,000 x 22% = $3,300.)

If you owned the home for one year or longer, then you’d be liable for the long-term capital gains tax rate. Your income and filing status make your capital gains tax rate on real estate 15%. Therefore, you would owe $2,250.

Real estate capital gains tax

How To Avoid Capital Gains Tax On Real Estate

Appreciation on real estate is a great thing, depending on how you look at it. However, as a seller, that could translate to thousands, or even hundreds of thousands, of dollars in taxes after a home sale.

Fortunately, there are a few things homeowners and investors can do to offset their capital gains tax on real estate:

  1. Offset Gains With Losses

  2. 1031 Exchange

  3. Convert Rental Property To Primary Residence

1. Offset Gains With Losses

One of the simplest ways to reduce your exposure to the capital gains tax is to offset the profits made from selling a home with losses that have been realized from another investment. While the Internal Revenue Service (IRS) taxes profits made from investments, they also allow investors to deduct losses from their taxable income. Otherwise known as tax-loss harvesting, this particular strategy reduces exposure to taxes levied on gains. By accounting for both gains and losses, investors can reduce the amount of capital gains they are taxed on.

2. 1031 Exchange

The 1031 Exchange, named after Section 1031 of the IRS tax code, allows investors to put off paying capital gains taxes if they reinvest the proceeds made from selling a rental property into another investment.

The 1031 Exchange is a valuable tool for investors looking to shelter their profits from taxes, and it can be used as many times as necessary. However, taxes will be due the moment profits are realized. In other words, the 1031 exchange merely puts off paying capital gains taxes until sellers hold onto the proceeds from a home sale.

3. Convert Rental Property To Primary Residence

The IRS grants better tax benefits to those who sell a primary residence than investors who sell rental properties. It’s becoming commonplace for rental property owners to convert their investments into primary residences before carrying out the subject property’s sale. That way, they’ll be able to offset some of the capital gains taxes levied in their direction.

To make the deduction, homeowners must meet specific criteria set forth by the IRS. Namely, they must have owned the home for at least five years. Additionally, the homeowner must have lived in the subject property for two of the five years leading up to the sale. That’s an important distinction to make, as the amount of time the investor lives in the home (relative to the time it was placed in service) will help determine the amount allowed to be deducted.

Summary

If you’ve ever wondered if there is capital gains tax on real estate, then the answer is yes. The good news is that these taxes are not that much more complicated than your income tax and are not realized until you’ve sold the property. If you’ve owned the property for less than one year, then you’ll end up owing more capital gains tax than if you’ve held onto it for more than one year. Thus, the tax structure incentivizes you to buy and hold real estate.

Have you ever sold property without realizing that you’d be subject to real estate capital gains tax? Did you own the property for over or under one year? Share your story and any tips you might have in the section below:


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