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Will I Have To Pay Capital Gains When I Sell My House?

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Capital Gains…
To Pay Or Not To Pay
That is the Question

When you buy a home, it’s hard to think about anything else. You’ve been through so much trouble finding the perfect place, remodeling, making memories and then the day comes when you have to sell.

The market has been great the last few years and you have quite a bit of equity. You may have heard somewhere that your home is considered a capital asset. What happens next?

The good news is most people don’t have pay taxes because their homes qualify as “exempt property.” The bad news: Not every single person who owns real estate falls into these exempt categories.

Let’s take a quick look at your choices:

Taxpayer Relief Act of 1997

2 in 5 Year Rule

How Does Capital Gains Work With Primary Residence

1031 Exchange

Convert To Primary Residence

The 1997 Taxpayer Relief Act was a huge step towards simplifying taxes. The legislation introduced some new tax credits that remain in place today. Now-familiar concepts such as the child credit and Roth IRA were created with this act, which also reduced rates for individuals filing taxes lower than they had been before.

The act exempted from taxation any capital gains on the sale of personal residence up to $500,000 for married couples filing jointly and $250,000 if you’re single.

This exemption only applies when taxpayers have occupied their homes two out five years ago, so make sure it’s worth your time before applying this deduction again next year.

The 2 in 5-year Rule

For taxpayers that have more than one home, the IRS allows for a tax break on only one’s primary residence, but there is some leeway in determining which home qualifies.

In layman’s terms, this mean that during the last five years, you would have lived in the home for a total of two years, or 730 days for it to qualify as your primary residence. The block of time may not need to be consecutive. (Make sure you speak to your tax professional for specific advice.) Married taxpayers filing jointly, each spouse needs to meet the tax rule.

How Does Capital Gains Work With Your
Primary Residence

The act exempted from taxation any capital gains on the sale of personal residence up to $500,000 for married couples filing jointly and $250,000 if you’re single.

For example, let’s say you purchase a new home for $400,000. You live in it for the first year, you decide to rent the house for three years, then the tenants decide to move out, so you move in and live there for another year. After the five-year mark, you decide to sell the house for $600,000.

In this scenario, no capital gains tax is due. The profit ($600,000 – $400,000 = $200,000) does not exceed the exception amounts. Now let’s take a look at another scenario where the values are over and above the exception.

In this example, you sell your house for $700,000. The capital gains tax is taxed on the $50,000 ($700,000 profit – $400,000 original purchase price = $50,000 capital gains taxable amount). There are ways to offset the capital gains taxable income, but you should speak to a professional tax advisor to find out if you qualify.

When Is The Sale Fully Taxable?

Not everyone is able to take advantage of the capital gains exclusions. Here are some examples of when the sale of a house can be fully taxable:

  • It is not a primary residence
  • The real estate was purchased through a 1031 exchange (more below)
  • The seller is subject to expatriate taxes
  • The house was not owned and used as a primary residence for at least two of the last five years prior to the sale
  • The seller sold another home within two years and the capital gains exclusion was already used

1031 Exchange

Homeowners, individuals, trusts, and corporations can take advantage of the 1031 exchange. Executing a 1031 exchange is a complex process and you should consider working with a reputable 1031 exchange company.  

The 1031 exchange is not for personal use and is used for business or investment purposes. The “party” to the 1031 exchange must, in writing, identify the replacement property within 45 days from the sale and must complete the exchange/sale for a comparable property within 180 days.

Some of the main requirements are:

  • Like-kind investment property must be purchased
  • The replacement property needs to be of equal or greater value
  • All the proceeds need to be invested in the sale
  • Needs to be the same taxpayer/title holder
  • New property must be identified within 45 days
  • New property purchase must take place within 180 days

Convert Your Investment To A Primary Residence

Gains on rental properties and non-primary residences do not receive the same exemptions and therefore, investors get imaginative for ways to reduce their capital gains tax. One way to do this is to move into a rental property or 2nd home and make it their primary residence.

A property owner can make a 2nd home their main primary residence for two years before selling and taking advantage of the capital gains exclusion. There are, however, conditions that apply. Again, you should solicit the advice of a tax professional.

Final Thoughts

The Taxpayer Relief Act of 1997 allows taxpayers to exclude from taxable income up to $250,000/$500,000 of capital gains on the sale of their principal residence. In order to qualify for this exclusion, the taxpayer must have owned and used the property as their principal residence for two out of the five years preceding the sale. There are also a number of other requirements that must be met in order to take advantage of this provision. If you meet all of the requirements, you may be able to avoid paying taxes on any gain realized from the sale.

If you are considering selling your home in Southern California, We Buy Any House In California is always looking to purchase more houses. We have streamlined the process and keep overhead low by not advertising on expensive T.V., radio and billboard ads. Because of this, we are confident we can offer you the highest and best offer and provide any additional help you may need. We buy houses in any condition, any reason, or situation, we have a solution for you. Please visit our How It Works page for specific information on how we formulate offers and our About Us page to get to know us better.

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