What Tax Do You Pay When Selling a Home?
Laura answers a listener question about how to cut taxes when selling a home. Find out what the capital gains tax is, how it's figured, and six tips to legally sell your home tax free.
Page 1 of 5
Valerie H. says, “My mother has started thinking about selling her house and moving into a senior apartment. She purchased her California home over 20 years ago for $180,000 and now believes she could sell it for $550,000. Is there a legal way to cut the huge tax bill she would receive?”
Valerie, this is a great question that affects everyone who sells a home and makes money on the deal. In this post I’ll explain the capital gains tax you pay when selling a home and 6 tips to legally sell your home tax free.
Free Resource: Laura's Recommended Tools—use them to earn more, save more, and accomplish more with your money!
What Is the Capital Gains Tax?
You already know that you have to pay tax on income from your job or interest from a bank savings account. Those are examples of ordinary income, which is taxed at some of the highest rates in the U.S.
But there’re another type of tax that you must pay when you make a net profit on an investment, such as stock or real estate. It’s called the capital gains tax—and, fortunately, it can be lower than the rate you have to pay on ordinary income. That’s the government’s way of encouraging you to be a long-term investor.
I’ll explain the basics of the capital gains tax and the special rules you should know that apply when you sell your main home.
Capital gains tax is triggered when you sell a capital asset for more than you paid for it. For instance, if you own stock or real estate that appreciates year after year, you don’t pay capital gains tax until you actually have a gain.
In other words, a profit that only exists on paper doesn’t cost you anything. The tax only kicks in when you sell the asset and bank the profit.
Let’s say you bought 500 shares of Apple stock in 2011 for $25,000 when the price was $50 a share. But now the stock is worth $100 a share, or $50,000, in 2016.
If you decide to sell all of your Apple stock, you’ll happily make a $25,000 ($50,000 selling price - $25,000 purchase price) profit—but also have to pay capital gains tax on that amount.
What Is a Capital Loss?
It’s also important to understand that capital gains can be reduced or offset by capital losses, such as selling a stock for less than you paid for it. Losing money on an investment is never fun, but when it can cut your taxes, it reduces the sting a little.
Capital losses can be subtracted from capital gains. However, there are limits on the amount of loss you can declare. Only $3,000 (or $1,500 if you’re married and file taxes separately) of net capital losses can be deducted from your income in a given year.
But if you have net losses that total more than $3,000, you still get to capture them. You can roll over capital losses into future tax years until the entire amount has been deducted from your income.
However, selling your primary residence for a loss is an exception and this trips up a lot of people. You can’t deduct capital losses on real estate that is also your primary residence—only on investment property.
So if you lose money on the sale of your main home, it can’t be “written off” or deducted from your taxable income.