Arizona Commercial Real Estate

How Much Will You Pay in Capital Gains Tax on Real Estate?

When you sell real estate you’ve held as an investment, the rate at which you’re taxed for making a profit from it may vary depending on how long you’ve held it, and whether it is a home, or other type of real estate.

Home sales, being a specific type of capital gains, have their own set of rules.

Profits from selling something you’ve held less than a year are taxed as “short-term” capital gains, and are pegged to your federal income tax bracket. You’ll pay short-term capital gains at the same rate you pay your income taxes, which vary depending upon your income. You can see the tax brackets here.

With the signing of the 2017 Tax Cuts and Jobs Act into law on Dec. 22, 2017, the reforms instituted by it resulted in a recalculation by the Internal Revenue Service of everything from tax rates on income (five of seven tax rates were lowered by 1% -4%) to changes in long-term capital gains tax brackets.

In early 2019, the IRS announced inflation adjustments, which included a revision to the long-term capital gains tax brackets.

Long-term capital gains taxes apply to profits from selling something you’ve held for a year or more. The three long-term capital gains tax rates of 2018 haven’t changed in 2019, and remain taxed at a rate of 0%, 15% and 20%. Which rate your capital gains will be taxed depends on your taxable income, and filing status.

Here’s the breakdown for the long-term capital gains tax rates for 2018:

Individual Rate:

Married, filing jointly:

Married, filing separately:

Head of Household:

For 2019, the long-term capital gains tax rates will be the same, but the income amounts will have changed:

Individual Rate:

Married, filing jointly:

Married, filing separately:

Head of Household:

Examples of Capital Gains Tax on Real Estate

Let’s say you’re married, so you and your wife file a joint tax return. Let’s say you have a combined taxable income of $200,000 in 2019, putting you in the 24% marginal tax bracket in both 2018 and 2019.

You purchased a small piece of land in California a little less than a year ago, thinking maybe it would make a future home, and you sold it when you discovered your wife was pregnant because you thought you might need more cash on hand. You netted $10,000 profit from when you bought it. If you sold it now, before having held it a year, it would count as ordinary income or a short-term capital gain, and you’d be taxed $2,400 for it.

If, however, you waited just one more month to sell it, it would count as a long-term capital gain, and be taxed because of the gain’s value and your income at the 15% long-term capital gains rate. Meaning, you’d pay $900 less, or $1,500 for it. Which would be an $8,500 gain on the investment.

Here’s another example.

You’re single, and you bought a piece of farm land in Oklahoma with a building on it for $200,000. You figured you’d upgrade it and maybe retire there when you’d amassed a fortune. Then, you realized you needed the cash to pay off debt. So you sell it for $300,000, netting a $100,000 profit (gain) from your original purchase price. You’re single, but you’re making between $40,000-$80,000 a year. You sell the land before you’ve held it a year. Your income puts you in the short-term capital gains bracket of 22%. So, you could owe $22,000 on your $100,000 capital gain. Now suppose being a savvy land investor, you realized you could get at least $300,000 months from now, if you wait until you’d held it a year. Your long-term capital gain, because of your income, would fall in the 15% bracket. So you’d pay $15,000 on the $100,000 gain, saving you $7,000.

You see, it pays to hold onto any item — real estate or personal property — more than a year.

How Much Can You Exclude?

Now, there’s more good news. Based upon IRS Section 121 exclusion, if you sell the main home you live in, the IRS lets you exclude — not be taxed on — up to $250,000 of capital gains on real estate if you’re single. If you’re married, and file your tax return jointly, the IRS is even more generous, letting you exclude typically up to $500,000 in capital gains. That’s thanks to a Taxpayer Relief Act of 1997. You’re eligible for the exclusion if you have owned and used the home as your main home for a period totaling at least two years out of the five years prior to its date of sale.

Let’s say you bought a home 10 years ago for $200,000 and sold it now for $500,000. You made $300,000. If you’re married and filing jointly, none of that gain would be typically subject to the capital gains tax. If, however, you sold it for, say, $800,000, up to $500,000 of your gain would be excluded, but you’d possibly be subject to paying capital gains on the $100,000 of that gain — the amount over $500,000.

However, a number of factors could make it so you can’t take the exclusion allowed when selling your home. Items that disqualify you from taking the normal exclusion on your capital gains include if you’re subject to expatriate tax; the house or real estate you sold wasn’t your principal residence (use requirement); you owned it for less than two years in the five-year period before you sold it (ownership requirement); or you didn’t live there for at least two years in the 5-year period before you sold it.

Any gain you can’t exclude is taxable.

But, the IRS has made exceptions.

If you’re married and filing jointly, only one of you needs to meet the ownership requirement of owning it for two years and living in it as your main home for two years or more during the 5-year period ending on the date you sold or exchanged the home to qualify for the exclusion.

Even if you don’t meet one or both of the above two requirements, you can still can claim an exclusion if you sold or exchanged the home because of a change in place of employment, health, or certain unforeseen circumstances. In this case, the maximum amount of gain you can exclude is reduced, according to the IRS. For more information, see IRS Publication 523.

Also, if married, filing jointly, but your spouse died before the sale or exchange, you can still exclude up to $500,000 of gain if:

• The sale or exchange is no later than two years after your spouse’s death;
• Just before your spouse’s death, both spouses met the use requirement, and at least one spouse met the ownership requirement, and
• You didn’t remarry before the sale or exchange.

You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve outside the U.S. “as a Peace Corps volunteer or serve on qualified official extended duty as a member of the uniformed services or Foreign Service of the United States, as an employee of the intelligence community, or outside the United States as an employee of the Peace Corps,” the IRS notes.

This means you may be able to meet use and ownership tests even if, because of your service, you didn’t actually use the home as your main home for at least the required two years during the 5-year period ending on the date of sale.

However, the five-year period can’t be extended for more than 10 years, the IRS notes.

There are two other possible scenarios under which you can’t take the exclusion you’d normally be allowed: you already took an exclusion on another home in the two-year period before selling your current one, or you purchased the house in a like-kind exchange in the past five years.

Lastly, if you are selling your principal residence, and say for a lot more than you’d paid for it, you are allowed to add to the original cost of everything from remodeling, to new windows, landscaping, new driveways, expansions, landscaping, fencing and even air conditioning installations. The greater the cost basis on which the capital gain is assessed, the lower the gain subject to tax.

How Do You File Your Capital Gains Tax?

The IRS says you should report your capital gains and losses on Schedule D and report the amounts on your Form 1040.

If you receive Form 1099-S, Proceeds From Real Estate Transactions, you must report the sale of the home even if the gain from the sale is excludable under the IRS Section 121 exclusion.

If you have to report the sale or exchange of your home, report it on Form 8949 first. Instructions for Form 8949 are on the IRS website.

Also keep in mind, when you sell investments you may be subject to an additional 3.8% net investment income tax. Some investors may owe the additional tax that applies to whichever is smaller: the net investment income or the amount by which modified adjusted gross income exceeds certain income thresholds ($200,000 single or Head of Household, $250,000 married filing jointly).