A net gain of $590k on a home sale will put at least some of the money up to potentially be taxed, regardless of your circumstances. But in many cases, you won’t have to pay taxes on that full amount.
A home seller normally can exclude a gain of up to $500,000 from federal taxes when selling their principal residence. That is only for a married couple who file tax returns jointly, however. An individual filer can exclude only up to $250,000. But no exclusion may be available if the seller has not lived in the home for at least two of the previous five years, or if they’ve previously taken advantage of the exclusion up to those lifetime limits.
Other details may also influence your applicable taxes on the net of $590k. In addition, several strategies exist that can sometimes reduce or eliminate taxes on a home sale when downsizing. While we’ll review the overarching rules below, the nuances of your specific situation may be clarified by a consultation with a financial advisor.
When you sell an asset for more than you paid for it, the IRS considers the amount of the gain to be a taxable capital gain. This applies to the sale of any type of asset, including stocks, bonds and investment real estate. However, when selling a personal residence some or all of the gain may be excluded from taxation. The excluded amount can be up to $500,000 for a married couple, or $250,000 for a single filer.
This exclusion is not always available, however. It’s only allowed if the seller has lived in the home as a principal residence for at least two of the previous five years. If the seller has lived in the home for less than a cumulative two of the previous five years, the entire gain would be taxable. And it’s only for a principal residence. Vacation homes, second homes and investment property don’t qualify. Finally, the exclusion counts for your whole lifetime. So, if you’ve used the exclusion previously on a different home sale, that use would subtract from your available remaining exclusion.
The applicable tax rate also depends on the specific circumstances. For example, if the seller has owned the home for less than a year, any taxable gain is considered a short-term capital gain. This kind of gain gets the same treatment as ordinary income and the tax is calculated using the regular federal income tax brackets. These go up to a top marginal rate of 37%.
If the seller has owned the home for at least one year, on the other hand, a different set of tax tables applies. These are the long-term capital gains tax tables, and they are much lower than ones used for ordinary income. Depending on the seller’s income, the capital gains rate may be from zero to a maximum of 15%.
A married couple who netted $590,000 from a move to downsize in preparation for retirement would not be able to exclude any of the gain if they had lived in the home for less than two of the previous five years. This means the entire $590,000 could be subject to taxes.
If, however, they had lived in the home for at least two of the previous five years, they could exclude up to $500,000. That would leave up to $90,000 as the taxable portion of the gain. If the seller is single, or a married person who files singly, the exclusion is limited to $250,000. That would leave $340,000 to be taxed.
The applicable tax rate depends on, first, whether the seller has owned the home for at least one year before the sale and, second, the seller’s income tax bracket. For example, if the seller has not owned the home for at least one year, the gain would normally be taxed as ordinary income. The applicable income tax percentage would depend on the seller’s income. For a sale where the home was owned for more than one year, the preferred capital gains rates of 0%, 15% or 20% would apply, instead of regular income tax rates. Your capital gains tax rate is also dependent on your income.
A financial advisor can help you determine whether you’ll owe taxes on your home sale depending on your specific circumstances. Get matched with a financial advisor.
There are some other ways to manage taxes on gain of the sale of a home. One is to apply any adjustments to in the home’s cost basis. The costs of some improvements essentially can be deducted from the sale price, reducing the amount of the gain. For instance, if the home seller had previously spent $60,000 to add a room and $30,000 to replace the roof, this $90,000 adjustment to the cost basis might reduce the taxable gain for a married seller to zero.
It may also be possible to use tax-loss harvesting, applying a loss on the sale of another asset to reduce the capital gain. For instance, if the seller had sold stocks for a loss of $50,000, this could be used to reduce the capital gain by that much. If that happened, the taxable gain for the married seller could be reduced to $40,000.
A more intricate strategy called a like-kind exchange could defer although not eliminate capital gains taxes on the gain. This approach, also called a 1031 exchange, allows a real estate owner to trade one investment property for a lower-priced one without immediately owing any taxes on the difference in the prices of the two properties. Like-kind exchange can only be used for investment property, however. It may be possible to do a like-kind exchange when downsizing, but it would require renting out the home being sold for at least two years before the sale. Then the home being purchased would also have to be rented out for a similar period after the sale before it can be used as the retiree’s principal residence.
For help with a capital gains strategy for your home sale and beyond, consider matching with a financial advisor.
You may be able to exclude all or part of the gain when selling a home if you have lived in the home for two years before the sale. The allowable exclusion is $250,000 for single filers and $500,000 for married couples. If the gain is more than the exclusion allowance, or there is no exclusion available, the applicable tax rate on the taxable amount depends on how long the home was owned by the seller before the sale. Up to one year, the gain is likely to be taxed as ordinary income. If it was owned for more than a year, lower long-term capital gains taxes may apply.
SmartAsset’s Capital Gains Tax Calculator is a fast and free way to estimate how much the capital gains tax could be when selling real estate, stocks or other assets.
A financial advisor can help you determine what your tax liability could be when selling your home. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Heather Ochoa is a news writer at the Failsafe Podcast. She has been writing about politics, health, business, parenting and finance for over a decade. She also loves to go hiking in her free time.
