Published On: Mon, May 20th, 2024

Avoiding Capital Gains Taxes on Home Sales

By Ashley Tison, Founder — OZPros 

Not everything about skyrocketing home prices is excellent news for sellers. In fact, the soaring real-estate market means many homeowners face capital gains tax.

The capital gains exclusion, allowing single homeowners to exclude up to $250,000 and married couples to exclude up to $500,000 of gain from their income, has not been adjusted for inflation. Many homeowners find their gains exceeding these thresholds and incurring capital gains taxes.

In this climate, capital gains taxes can significantly eat into your profits. However, with careful planning and understanding of the tax laws, minimizing or even avoiding capital gains taxes on home sales is possible.

How capital gains taxes work

When it comes to significant investments such as real estate, it is crucial to not only consider your potential gains but also understand the implications of capital gains taxes. Capital gains tax is a tax levied on the profits earned from selling assets, such as stocks, real estate, or businesses.

In a nutshell, capital gains taxes are calculated based on the difference between the sale price of an asset and its original purchase price, commonly referred to as the capital gain. The basis of your home is what you paid for it, plus improvements and certain other costs. When you sell, your proceeds minus your basis equals your capital gain. For example, if you bought your home for $200,000, spent $50,000 on improvements, and sold for $500,000, your gain would be $250,000.

The tax rate applied to this gain depends on various factors, including the type of asset and how long it was held before being sold. The capital gains tax rates in the US range from 0% to 20%, depending on your income bracket.

Strategies to avoid capital gains taxes

One of the most effective ways to avoid capital gains taxes is to meet the residence requirement. You may qualify for the Home Sale Exclusion if you have lived in your home as your primary residence for at least two out of the last five years before selling. Under this provision, you can exclude up to $250,000 (or $500,000 for married couples) of capital gains from your taxable income.

Another strategy to defer capital gains taxes is through a 1031 exchange. This provision allows you to sell your current property and purchase a similar investment property within a specified time frame without recognizing the capital gains. Doing this will enable you to reinvest in real estate and defer the taxes until you finally sell the property for cash. Keep in mind that there are specific rules and timeframes to follow and that this only applies to investment property, so consulting a tax professional is crucial in implementing this strategy.

Ways to minimize capital gains taxes

If you plan to sell your personal residence in 2024, the timing of your sale can significantly impact your capital gains taxes. If you anticipate a substantial increase in your income in the near future, consider holding off on selling until your tax bracket changes. Planning the sale to coincide with a lower income can reduce the overall tax rate applied to your gain.

Additionally, waiting until you’ve held the property for more than a year can qualify you for long-term capital gains tax rates typically lower than short-term rates. By holding investments for more than a year, you may qualify for lower tax rates.

Another way to reduce your capital gains taxes is by considering capital improvements to your home. By investing in renovations, upgrades, or additions that increase the value of your property, you can adjust your cost basis and reduce the overall taxable gain. Keep thorough records of the expenses and consult with a tax professional to ensure your improvements qualify. Another tactic involves taking advantage of tax-advantaged accounts such as IRAs or 401(k)s, where gains can grow tax-free or tax-deferred until withdrawal.

You could take advantage of the “step-up in basis” rule if you inherited the property. This means the property’s value is re-assessed at its fair market value on the date of inheritance. If you sell the inherited property shortly after, the capital gains will likely be minimal or non-existent since they are calculated based on the difference between the date of inheritance value and the sale price.

You can also attempt to offset gains with losses. Capital losses can be used to offset capital gains, reducing your overall tax liability. This practice is known as tax-loss harvesting and involves strategically selling investments at a loss to offset gains.

Finally, consider charitable giving. Donating appreciated assets to qualified charities can provide a dual benefit of supporting a cause you care about and potentially reducing your taxable capital gains.

Mitigate capital gains taxes by investing in opportunity zones

You can also improve your capital gains tax liability by investing in a hidden gem tax mitigation program known as opportunity zones. Congress signed the opportunity zones program into law as part of 2017’s Tax Cut and Jobs Act. This program encourages private investment in low-income neighborhoods by enabling you to benefit from capital gains tax benefits while receiving returns on your investment. By reinvesting the gains from the sale of your home into opportunity zones, you not only make a difference in struggling communities but also defer and potentially eliminate your capital gains taxes.

If navigating the complexities of capital gains tax, exclusions, and potential investments in opportunity zones seems daunting, an expert can help optimize your tax strategy. Tailoring these strategies to your specific situation will maximize their benefits and enable you to keep more of your hard-earned profits.

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