4 Things to Know About Capital Gains Taxes Before Selling a Home
When someone sells a piece of property that increases in value, the difference between the original purchase price and the final sale price is considered a capital gain. Depending on a few factors, home sellers could face tax liability for their capital gains. There are deductions that sellers can make on their taxes related to upgrades to the property and other things. With this information, you'll understand the basics of capital gains taxes and the most common deductions and be able to focus on preparing to move to your new home.
What Are Capital Gains Taxes?
A capital gain is a type of income; people usually need to pay taxes on at least a portion of it. Common investments that might involve capital taxes include:
- Real estate
For example, a real estate investor who owns rental properties would be expected to pay capital gains taxes when they sell one of those properties for more than they paid. If they sell it for less than they paid, that is considered a capital loss. People who make other types of investments may also need to account for capital gains or losses on their taxes. Similarly, someone who sells a property may have a capital gain, creating a tax liability. There are exceptions to the rule, but they depend on how the property was used and a few other factors.
Who Has to Pay Capital Gains Taxes?
People may be liable for capital gains taxes whenever they sell a capital asset. As a general rule, people selling a primary residence or transferring property to a spouse are exempt from paying capital gains taxes on the sale or transfer. Sellers should make sure that the property qualifies as a primary residence. Specifically, the seller (or member of their immediate family) must be living in the home as a primary residence during the year of the sale. This exemption does not apply to homeowners who donate a property to charity or transfer ownership of the property to someone who is not a spouse. Capital gains taxes may apply for any other property sale or return on investment.
How Are Capital Gains Taxes Calculated?
Typically, capital gains taxes are calculated on half of the gain. It is essential to remember that the gain's taxable amount is not the same as the tax liability. For example, if someone buys a home for $400,000 and sells it later for $500,000, the gain in question is $100,000. If the seller is not eligible for an exception for a primary residence, they may have to pay taxes on 50% of the gain. In this case, they would pay income tax on $50,000. The seller would be liable for taxes on that $50,000 in income related to their tax bracket.
Are There Capital Gains Tax Deductions?
There are a few ways sellers can minimize their capital gains tax liability, and they should research them before starting the selling process. Typically, a capital gain is the difference between the sale price and the original purchase price, subtracting investments made into the property. The original purchase price is usually referred to as the cost base. A homeowner who makes value-adding home improvements while they own it may be able to deduct at least some of the costs of those upgrades, creating an adjusted cost base for the tax assessment.
Typically, homeowners should be prepared to show proof of the investment. It's important to remember that there are annual limits on capital gains deductions.
Plan Ahead For Capital Gains When Selling Your Home
Understanding capital gains taxes is an integral part of the selling process. By planning in advance, sellers can ensure that they know which exemptions and deductions might apply to them and can use this information to reduce their tax liability.