After the phenomenal real estate market of the past few years, those who’d like to sell could reap significant capital gains over and above what they originally paid for their homes. Those who sell should know how the Internal Revenue Service will tax those profits.
From time to time we hear the federal government will modify the tax law’s breaks for capital gains. But any such change would only apply to very high-income homeowners. The law continues to be seller-friendly. Therefore, most home sellers do not owe taxes on their home sale profits.
Selling Your Home? You Probably Won’t Owe Taxes on Your Profit
From 2020 through 2022, home values shot up remarkably. In 2023, sellers aren’t calling the shots so much, and homes seem poised to appreciate at a rate we consider more normal: around 5% per year. By now, many home buyers are sitting on a lot of equity and can sell at a profit.
☛ Read more about patterns in real estate prices, and how a home’s value can help you save for the future.
Yet sellers of homes they owned and lived in for at least two years won’t pay capital gains tax on a 2023 sale if their individual taxable income was $44,625 or less. (Double that for married joint filers or an eligible surviving joint filer.) Check IRS Publication 523, on selling a home, for updates each year. People who earn more would be taxed at the 15% rate, but…
There’s a capital gains exclusion for sales of real property allowing a seller to avoid paying federal tax on any gain. Whew! Once in every two-year period, you can sell your primary residence while excluding up to $250,000 in profit from federal taxes. Note that the exclusion applies only to a primary residence you’ve lived in for at least two of the five years before you sold.
In other words: Say your home sale brings a profit under $250,000 (or $500,000 for a couple filing jointly). This is true for most people, so most do not face a capital gains tax. For profits over that exclusion threshold, there’s a scale based on income. According to the IRS, the tax rate on capital gains will not exceed 15% for most people.
So far, so good.
☛ Homeowners must also check their state’s tax rules. Here’s where you can check the tax rate your state applies to capital gains.
Short-Term or Long-Term?
If you don’t hold for two years, what then? Homes, like other capital assets, are taxed based on how long they’re held before a profitable sale.
Most sellers need to have held the home as a personal residence for at least two years of the past five (up to the closing date) to qualify for long-term gains.
Profits on assets held up to one year are short-term capital gains, taxed as regular income. Profits on assets held over a year get the lower long-term gain rate. The IRS has the scoop in its fact sheet on capital gains and losses.
☛ Did you sell an inherited home? Note the special tax rules for your situation. Check your state’s tax rules too!
We should point out that not everyone has to meet a length-of-residency minimum. There are special rules for deed holders who transfer their rights because of a divorce. Deployed personnel also have special rules allowing easier eligibility for capital gains tax breaks. If you must sell before two years, you may still be eligible for a portion of the exclusion.
☛ Rentals and other investment properties don’t get the capital gains exclusion. A separate provision applies for deferring capital gains by reinvesting. See: For Property Investors: Six Steps to a 1031 Exchange.
The rule that the property must be owner-occupied means a total of two years in the past five — they need not be two continuous years. Note: Gains during the time a property was rented out would still be subject to income tax.
Nuts and Bolts of Taxes
When you close your sale, you receive IRS Form 1099-S, Proceeds from Real Estate Transactions, from the lender or real estate agent for reporting the proceeds. If you can exclude your profit from capital gains tax, as most people can, advise your agent by Feb. 15 of the following year. If you sell a home in 2023, according to the IRS: “The due date for furnishing statements to recipients” for Form 1099-S “is February 15, 2024.” Lenders or real estate agents need to file a Form 1099-S, with the IRS only if you can’t exclude your taxable gain on your income tax return.
How do you report a gain or loss from the sale of your primary residence?
- In Form 1099-S of your tax return, Box 2, you’ll write the total gross proceeds.
- Subtract the agent’s commission and other selling expenditures you made. These include appraisal fees, recording fees, and escrow fees.
- Subtract your original tax basis — what the home cost when you bought it, closing costs and fees, and the value you contributed with upgrades, additions, or accessibility conversions.
- Subtract from your net profit any costs of selling (closing, commissions) that you paid.
Now you have a figure for capital gains if you profited from your sale.
Sellers, Plan Ahead for a Successful Deed Transfer
Remember to check up on the latest tax laws, state as well as federal. Very few people like to do this, granted. At least the IRS is planning to make tax returns easier in the years ahead.
The IRS received millions of dollars through the Inflation Reduction Act to test out a free, online tax prep and filing service. Here’s the May 2023 IRS report to Congress, which concludes “that there is taxpayer interest in an IRS-run free Direct File option” and that “Direct File should be considered among future options for agency technological transformation and customer experience improvement.”
So far, most homeowners have had to seek out accountants and tax experts for advice on deductions for appreciation, offsetting capital gains, and knowing when it’s wise to report taxable gains, even when they’re subject to exclusions.
Which leads us to an important disclaimer. This article is offered as general information and not legal or tax advice. For guidance on tax matters when selling your home, read the IRS instructions as they apply to you, and speak with a licensed tax pro.
☛ Not ready to sell? It’s still worth taking the time to brush up on tax tips you’ll need all year.
Supporting References
U.S. Internal Revenue Service via IRS.gov: Frequently Asked Questions on Gift Taxes (page last reviewed or updated on May 31, 2023).
Deeds.com: For Home Sellers: Capital Gains Tax 101 (Mar. 29, 2021).
Deeds.com: Your Mother Wants to Add You to the House Deed. Good Idea? (Jun 5, 2023).
Deeds.com: 2023 – 2028 in Real Estate – What Can We Expect? (Jan. 23, 2020).
Dept. of the Treasury, Internal Revenue Service. IRS Report to Congress: Inflation Reduction Act §10301(1)(B) IRS-Run Direct E-File Tax Return System (PDF; May 16, 2023).
James Royal for Bankrate.com: What Is the Long-Term Capital Gains Tax? (Mar. 10, 2023).
And as linked.
Photo credits: Nataliya Vaitkevich and RODNAE Productions, via Pexels.