For those of you who have filed for an extension on your 2018 taxes, this overview of capital gains tax on real estate may be helpful.

First of all, what is capital gains tax on real estate and who pays it?

Capital gains tax on real estate is a tax levied on property you’ve held for over one year that you have sold for a profit. Your home would be included in the definition of property.

The Internal Revenue Service gives each person, regardless of her/his respective earnings, a $250,000 tax-free exemption for a primary residence. To claim that tax-free exemption, these caveats apply:

  • the home must be your primary residence
  • you must have owned the home for at least two years
  • you must have lived in the home for at least two of the past five years.

For more information, consult a tax advisor and/or the IRS Publication 523.)

If the capital gains tax exceeds $250,000?

  • you pay 0% if you are a single filer earning less than $39,373/year
    • or you are married and filing jointly earning less that $78.750/year
  • you pay 15% if you are a single filer earning between $39,376 – $434,550
    • or you are married and filing jointly earning between $78,751 – $488,850
    • or you are a head of household and earning between $52,751 – $461,700
  • check to see whether or not your state has its own capital gains tax
  • very high earners may owe an additional 3.8% net investment income tax – check with a tax advisor

Do home improvements reduce capital gains tax?

  • the money you spent on home improvements can be added to the initial price of the house in order to give you an adjusted cost basis of the home.
  • let’s say you bought the home in 1990 for $200,000 and sold it for $550,000 in 2018 but you spent $100,000 on home improvements – that $100,000 would be subtracted from the sales price of the house so you would not be paying as much capital gains tax
  • keep any and all receipts for home improvements

How does the capital gains tax impact an inherited home? 

  • the IRS gives a “free step-up in basis” on an inherited home.
    • let’s say your parents bought the house for $100,000 and you are now selling the house for $1M
    • when you sell the home, the basis price is $1M only if the house was worth that price on the date of their death(s).
    • check with a tax advisor

How real estate investors may avoid capital gains?

  • the best way to avoid capital gains is to do what is known as a 1031 exchange
    • a 1031 exchange allows you to sell one property and buy another without recognizing any potential gain
    • essentially, you are swapping one property investment for another BUT there are strict rules regarding timelines and guidelines so check with a tax advisor
  • if you are opting out of a rental property investment business and putting that money into another venture, you will own capital gains taxes on the profit involved.
  • Again, check with a tax advisor.

For more online information, go to MarketWatch.com.