What You Need to Know About the Capital Gains Tax
Buying or selling a home is a complicated financial transaction. It's easy to think of real estate solely in terms of your dream house and a place to call your own, but the government recognizes your home as the major investment that it is. Because your property is potentially worth more than anything else you own, state, federal and local governments have a vested interest in taxing your property. In addition to your standard real estate taxes, you may also be affected by capital gains taxes when you sell your house. If your home has greatly appreciated in value as they tend to do in real estate markets like Southaven, it's important to understand what this all means.
What Are Capital Gains Taxes?
Capital gains taxes are levied when you sell an investment. Your home is considered a capital asset, or an investment, even though you live in it on a daily basis. Though you're not taxed on the home as it appreciates in value, you are taxed when you sell it—or, in tax-speak, when you realize your gains. If the future selling price of your home is higher than the price you bought it for, the difference—that is, your profit—may be subject to capital gains taxation.
Fortunately, the federal government allows for an exclusion of some or all of your capital gains. The first $250,000 in profit on your home's sale are exempt from capital gains taxes. If you're married filing jointly, the first $500,000 are excluded. If you end up earning more than your exclusion amount, the remainder of the profit is taxable as a capital gain. On the bright side, capital gains tax rates are lower than the taxes on your ordinary income, so you won't take as big a tax hit as if you earned that profit as a bonus at work.
Tips for Avoiding Capital Gains Taxes on Real Estate Transactions
When selling a home, it pays to pay attention to the details to make sure you can claim that capital gains exemption. Make sure your home qualifies as a primary residence, as people who own multiple residences cannot claim exemption on a vacation home or alternative residence. For most people, living at home is easy. If you travel, move between multiple homes, or have moved to a nursing home, be sure you can prove you lived in the house full-time for a total two of the last five years so you can claim your capital gains exemption.
Don't sell too frequently. You only get to claim a capital gains exemption on selling a house once every two years, so make sure you're timing the sale of your property well to avoid getting hit with a tax that could be avoided by waiting another month or two.
Plan Ahead When Buying. IRS rules state that you need to live in the house for two of the last five years, and this means that you also need to own the home for five years in order to claim an exemption on capital gains. If your job or life circumstances could force you to move in less than five years, proceed with caution. If you're able to hold on to the property and rent it out until your five-year grace period is up, you can avoid paying capital gains when you eventually sell.
Many people are able to avoid capital gains taxes with some smart planning and attention to detail. Talk to your real estate agent and accountant for additional advice on your situation.