What are capital gains?
A capital gain is 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 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 15% for most taxpayers.
How do capital gains work in real estate?
Capital gains taxes on the sale of real estate are similar to other capital assets. If you own real estate for more than one year before the sale, you will be taxed at the long-term capital gains rate. If you own the real estate for one year or less, you will be taxed at the short-term rate. The exact tax depends on your marital status, tax bracket, whether the property served as your primary residence, and other factors.
For 2023, single taxpayers and married couples filing jointly will not pay taxes on long-term capital gains up to $44,625 and $89,250, respectively. Single taxpayers may pay a tax rate of 15% for long-term capital gains between $44,626 and $492,300. Married couples filing jointly also may pay 15% for long-term capital gains between $89,251 and $553,850. The long-term capital gains tax rate is currently capped at 20%.
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 real estate 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 with Form 8949 and Schedule D. Because of the complexity of reporting the sale of real estate, you may want a tax professional to review your tax return.
How do capital gains affect my taxes?
When a capital asset is sold for a profit, the taxpayer may report the sale. Short-term capital gains are taxed as ordinary income. For tax year 2023, the highest rate for an individual is 37%. Long-term capital gains, however, have better tax rates.
Long-term capital gains are taxed at either 0%, 15%, or 20%, depending on other reported income. Most taxpayers pay 15% or less.
Some taxpayers may also be subject to Net Investment Income Tax (NIIT) on their long-term capital gains. The NIIT is a 3.8% tax for taxpayers with income above certain thresholds. NIIT applies for single taxpayers and married couples filing jointly with modified adjusted gross incomes exceeding $200,000 and $250,000, respectively. Because of NIIT, the total federal tax on long-term capital gains may be as high as 23.8%.
How can I avoid capital gains taxes?
One way to avoid 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, while a married couple filing jointly can exclude up to $500,000. Because the tax benefits are significant, property owners may move into an investment or rental property for two years prior to selling the property.
There are other ways to reduce capital gains taxes when selling real estate. In a 1031 exchange, for instance, you essentially swap one real estate investment property for another and defer the capital gains on the transaction. Special rules apply when conducting a 1031 exchange, so working with an attorney or tax professional can make the process easier.
Capital gains taxes may also be reduced by adding expenses such as closing cost, realtor fees, and capital repairs and improvements to your basis. Increasing your basis directly reduces the amount of net capital gains. Finally, losses from the sale of other assets can offset the capital gains of real estate sales. For example, if you sell stocks for a long-term loss of $20,000 and you have $50,000 of long-term capital gains from selling real estate, you can lower your net capital gain to $30,000.
Figuring out how to legally minimize taxes based on your specific situation can be confusing. If you need tax help, Rocket Lawyer can now match you with a tax pro for affordable and convenient tax filing services. Don't do your taxes™ – Let us do them for you. If you have questions about selling real estate or capital gains, you can also reach out to a Rocket Lawyer network attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.