As mentioned, there are two primary ways to avoid or defer capital gains taxes when buying a new home, one of which is the 121 home sale exclusion.
The 121 home sale exclusion, also known as the primary residence exclusion, is a tax benefit that allows homeowners to exclude a portion of the capital gains from the sale of their primary residence from their taxable income. This exclusion reduces the tax burden of selling a home.
How Does The 121 Home Sale Exclusion Work?
The 121 home sale exclusion comes with specific restrictions:
Eligibility: To be eligible for the exclusion, you must have owned and used the property as your primary residence for at least 2 of the 5 years preceding the sale.
Exclusion limits: Under this provision, a taxpayer can exclude up to $250,000 of capital gains on the sale of their primary residence if they’re filing as single or married filing separately. Married couples filing jointly can exclude up to $500,000 of capital gains.
Frequency of use: You can use this exclusion once every 2 years. Therefore, if you meet the eligibility criteria and haven't used the exclusion in the last 2 years, you can claim it again for a subsequent home sale.
What Kind Of Homes Are Eligible For The Home Sale Exclusion?
Numerous types of homes are eligible for the home sale exclusion, including:
Mobile homes
Trailers
Houseboats
Condominiums
Single-family homes
Cooperative apartments
Remember, property in a retirement community is eligible if the taxpayer receives equity in the property or a co-op if the taxpayer owns stock proportionate to their unit.
Are There Special Exemptions To The Home Sale Exclusion?
Unique circ*mstances sometimes accompany a home sale. Fortunately, you may still qualify for a tax benefit. Specifically, suppose you don't meet the 2-year ownership and use requirement due to specific unforeseen circ*mstances, such as a job change or health problems. In that case, you may be eligible for a partial exclusion based on the time you lived in the property.
Additionally, say you or your spouse are on qualified official extended duty for the U.S. military, the Foreign Service, or the intelligence community. In this case, you can extend the 5-year period for an additional 10 years, allowing yourself a wider timespan to live in the home. Remember, qualified official extended duty means more than 90 days or an indefinite period of service. In addition, you must be living at a duty station at least 50 miles from your primary residence or living in government housing due to government orders.
How Much Can You Save With The Home Sale Exclusion?
The examples below demonstrate how much a homeowner would pay in capital gains taxes in various situations.
Buying A New Home After Selling Current Residence
Here's an example demonstrating how much a married couple filing jointly would pay if their home sale profits exceeded the exclusion limits. Say you and your spouse purchased your home for $400,000. After owning and living in it for the last 30 years, you sell it for $1,200,000. You spent $100,000 on capital improvements while you lived there, meaning your cost basis is $500,000. Therefore, $1,200,000 − $500,000 = $700,000 of capital gains.
Since the capital gain of $700,000 exceeds the $500,000 exclusion limit for a married couple filing jointly, the portion of the gain above the limit ($200,000) will be subject to capital gains tax. In addition, say you and your spouse make $550,000 in 2024. This income level puts you at the 15% long-term capital gains tax rate for married couples filing jointly. So, $700,000 − $500,000 = $200,000 × 0.15 = $30,000. As a result, you would pay $30,000 in capital gains taxes on the portion of the gain exceeding the $500,000 exclusion limit.
In addition, if you and your spouse decide to use the proceeds from the home sale to buy a new home, you can use a portion or all of the sale proceeds as a down payment on the new property. However, the capital gains taxes you owe from the sale of your previous home will detract from your financial capabilities. Specifically, you will have $30,000 less to buy your next home than if you had received an exclusion for all of your capital gains taxes.
Moving Into A Vacation Home Or Investment Property
Using the example above, say you and your spouse sell your home, exceed the exclusion limit by $200,000, and move into your second home instead of buying a new one. This way, while you would still owe $30,000 in capital gains taxes, you wouldn’t worry about applying the profits from the home sale to a new home purchase. In addition, by making your second home your new primary residence, you can use the exclusion rule again in the future, provided you live in the house long enough.
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
The easiest way to lower capital gains taxes is to simply hold taxable assets for one year or longer to benefit from the long-term capital gains tax rate.
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
You must have lived in the house for at least two years in the five-year period before you sold it. Owning the home isn't enough to avoid capital gains on the sale — the IRS also wants to make sure that you actually intended to live in the house, at least for a certain period of time.
A capital gains rate of 0% applies if your taxable income is less than or equal to: $44,625 for single and married filing separately; $89,250 for married filing jointly and qualifying surviving spouse; and. $59,750 for head of household.
When does capital gains tax not apply? If you have lived in a home as your primary residence for two out of the five years preceding the home's sale, the IRS lets you exempt $250,000 in profit, or $500,000 if married and filing jointly, from capital gains taxes.
Since the tax break for over 55s selling property was dropped in 1997, there is no capital gains tax exemption for seniors. This means right now, the law doesn't allow for any exemptions based on your age. Whether you're 65 or 95, seniors must pay capital gains tax where it's due.
This means that if you sell your home for a gain of less than $250,000 (or $500,000 if married, filing jointly), you will not be obligated to pay capital gains tax on that amount. However, there are certain criteria you must meet to qualify for the home sale exclusion.
The capital gains exclusion applies to your principal residence, and while you may only have one of those at a time, you may have more than one during your lifetime. There is no longer a one-time exemption—that was the old rule, but it changed in 1997.
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
There is one tax benefit to these costs, though. You can add these closing fees to the cost basis of your home when you sell it. This lowers the amount of profit that you make. This can help reduce any capital gains tax you might have to pay on your home.
An investor's age does not by itself affect any capital gains taxes the IRS expects them to pay upon the sale of an asset. However, you can reduce your capital gains tax obligation in other ways. The length of time you hold an investment can significantly impact the capital gains you owe.
What is the CGT Six-Year Rule? The capital gains tax property six-year rule allows you to use your property investment as if it was your principal place of residence for up to six years whilst you rent it out.
Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.
It is generally paid when your taxes are filed for the given tax year, not immediately upon selling an asset. Working with a financial advisor can help optimize your investment portfolio to minimize capital gains tax.
Gains from the sale of assets you've held for longer than a year are known as long-term capital gains, and they are typically taxed at lower rates than short-term gains and ordinary income, from 0% to 20%, depending on your taxable income.
Long-term investing offers a significant advantage in minimizing capital gains taxes due to the favorable tax treatment for investments for longer durations. When investors hold assets for more than a year before selling, they qualify for long-term capital gains tax rates, typically lower than short-term rates.
When selling a primary residence property, capital gains from the sale can be deducted from the seller's owed taxes if the seller has lived in the property themselves for at least 2 of the previous 5 years leading up to the sale. That is the 2-out-of-5-years rule, in short.
Introduction: My name is Gregorio Kreiger, I am a tender, brainy, enthusiastic, combative, agreeable, gentle, gentle person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
