How Capital Gains Taxes Affect Home Sales and How to Avoid Them

Homeowners in the Greater Phoenix have seen their property value rise rapidly over the past two years. S&P CoreLogic Case-Shiller Index data shows that in May 2021, Phoenix saw a 25.9% year-over-year increase in house prices, leading the country for the 24th.e consecutive month. The impressive growth has led some to sell and capture the profits while the market is still warm. Those who expect a windfall profit, however, should be aware of the potential capital gains tax liability resulting from the sale of homes.

“Taxes are something people are really afraid of. And, frankly, most people should be because they don’t understand them, ”says Tom Wheelwright, CPA, CEO of WealthCapacity and author of “Tax Free Wealth”. “Capital gains are not separate from income tax, they are just a different rate for a different type of income. We normally think of income tax on the money we earn or collect from rent. Anything that is time-based income, like the appreciation of a house or a stock, is subject to capital gains tax rates, which are historically lower than regular income rates.


READ ALSO: Phoenix leads nation with 25.9% home price increase


When a house is sold, the profit is considered a capital gain and therefore exposed to taxes. There is, however, an exemption for the first $ 250,000 of profit for a single person or $ 500,000 for married couples, as long as the owner has lived in the property for two of the past seven years.

Tom Wheelwright is CPA and CEO of WealthAbility.

“For example, let’s say you paid $ 300,000 for your house. You’ve lived there for five years and are selling it for $ 500,000. That’s $ 200,000 in profit and you get an exclusion of $ 250,000, so you won’t pay any capital gains tax, ”notes Wheelwright. “But if you’re single and sell it for $ 700,000, you now have $ 400,000 in capital gains, so you’re going to pay capital gains tax on $ 150,000 – the difference between that gain of $ 400,000. $ 000 and the exemption of $ 250,000. “

If the proceeds of a transaction require the payment of capital gains taxes, that liability can be settled after closing or during tax time. The period of time between the sale and filing for taxes – potentially months depending on when the home was sold – can leave oblivious sellers unprepared for a surprise IRS bill. While this is a problem typically encountered by luxury home owners, Wheelwright says it is no longer the only case. “There are a lot of people who have owned their homes for a long time. With the increase in house prices, they are going to owe capital gains tax if they sell.

This issue is particularly important for people wishing to take advantage of the high valuation of their housing to improve their living conditions. “Imagine selling your house for $ 800,000 and buying a new one for $ 2 million because the interest rates are so low,” says Wheelhouse. “Now you have all that extra debt and you’ve already invested your profits in the new house. How will you pay your taxes if you have already spent these earnings? You will not be able to get a home equity loan.

There are ways to reduce the liability for capital gains from the sale of homes. Improvements to the property, such as re-flooring, adding a swimming pool, or renovating the kitchen, reduce the seller’s gain. The government also has incentives that offer tax deductions if the capital gains are spent in a certain way. For example, investments in real estate, oil wells, and business start-up costs all qualify for tax deductions.

“There is a tax credit for one dollar for installing solar panels on your roof. Credits are better than deductions because they are not based on your tax rate, they are 100% of the amount of credit allocated, ”says Wheelhouse. “If you put $ 100,000 of solar panels on your house, you get $ 26,000 off your income tax. Remember that anything you can do to lower your income taxes also lowers your capital gains taxes.

Wheelhouse says tax incentives are the way the government encourages spending to meet its goals. “You take a risk with your money the way the government wants it to, and that gives you a tax advantage as compensation. The government is your partner – either you are a silent partner or you are an active partner investing as it wishes.

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