What are capital gains?
A capital gain occurs when an asset is sold for more than what was paid. For example, if you buy a share of stock for $40 and later sell that share for $100, you have a capital gain of $60. The tax on that profit is called capital gains tax.
Capital gains are classified as either long-term or short-term. If you hold an asset for a year or less, you may be subject to short-term capital gains taxes. Assets held for more than one year may be subject to long-term capital gains taxes.
Net short-term capital gains are typically taxed at the same rate as ordinary income. Net long-term capital gains receive more favorable rates, which typically do not exceed a set percentage for most taxpayers.
How do capital gains work in real estate?
Capital gains taxes on the sale of real estate are similar to those on other capital assets. If you own real estate for more than one year before the sale, you’ll generally be taxed at the long-term capital gains rate. If you own real estate for one year or less, you’ll be taxed at the short-term rate.
The exact tax rate depends on your marital status, tax bracket, whether the property served as your primary residence, and other factors.
To determine the amount of capital gains on real estate, subtract your basis from the sale price. Your basis in the real estate is generally the amount paid for the property plus closing costs, real estate agent fees, and significant capital improvements such as a new roof or septic system.
The sale of real estate is generally reported on your individual tax return using Form 8949 and Schedule D.
How do capital gains affect my taxes?
When a capital asset is sold for a profit, the taxpayer must report the sale on their income tax return. Short-term capital gains are taxed as ordinary income. Long-term capital gains, however, are taxed at more favorable rates—typically 0%, 15%, or 20%, depending on your income level.
Some taxpayers may also be subject to the Net Investment Income Tax (NIIT), a 3.8% tax that applies to certain high-income individuals. You can learn more about the NIIT and its income thresholds on the IRS NIIT page.
How can I minimize capital gains taxes?
One of the most common ways to minimize capital gains taxes on real estate sales is to claim the primary residence exclusion. You are generally eligible if you owned and used the residence as your main home for at least two years during the five-year period preceding the sale date.
- A qualifying single taxpayer can exclude up to $250,000 of capital gain from the sale of a primary residence.
- A married couple filing jointly can exclude up to $500,000.
Because the tax benefits are significant, property owners may consider moving into an investment or rental property for two years before selling it in order to qualify for the exclusion.
There are other ways to reduce capital gains taxes when selling real estate. For example:
- In a 1031 exchange, you can swap one real estate investment property for another and defer the capital gains on the transaction. Special rules apply, so working with a knowledgeable professional can make the process easier.
- Increase your basis by adding expenses such as closing costs, realtor fees, and capital repairs or improvements. This reduces your net capital gains.
- Offset gains with losses from other asset sales. For example, if you sell stocks for a long-term loss of $20,000 and have $50,000 in long-term real estate capital gains, your net gain would be $30,000.
Figuring out how to legally minimize taxes based on your specific situation can be complex. If you need tax help or have questions about selling real estate or capital gains, you can also reach out to a Legal Pro for affordable legal advice.
Please note: This page offers general legal information, not but not legal advice tailored for your specific legal situation. Rocket Lawyer Incorporated isn't a law firm or a substitute for one. For further information on this topic, you can Ask a Legal Pro.
