Are you planning to sell a property and need to know if you must pay capital gains tax? Capital gains taxes are applied on profit made after a house or residential estate is sold. The taxes are paid depending on the ownership period, how long you have been a house resident, and if you are selling a personal residence. Read on as we explain how capital gain tax works and who pays it.
How Capital Gain Tax Works
After you have sold your house for more than what you paid, you could be subjected to pay taxes on the profit made. The tax on the profit is what is referred to as a capital gain tax. However, most people can avoid this tax since the IRS rule has allowed the exclusion of a certain amount of the gain from your taxable income.
Capital gain taxes and liabilities vary and are based on short-term or long-term property ownership.
- Short-Term Capital Gains. For sales investment or private property owned for a year or less, you will be subjected to a marginal tax rate. The marginal tax rate in 2023 falls between ten and thirty-five percent. This rate is usually equal to your ordinary income tax rate.
- Long-Term Capital Gains. If you have owned the property for over a year, you are expected to pay a capital tax on the profit made. The rates can range from zero percent to twenty-eight percent. However, twenty percent is what’s most common.
Evaluating The Capital Gain Tax
When selling or exchanging property, the taxable capital gain equals the value received minus the property’s cost-basis value. The basic property value is the amount the taxpayer initially invested in.
Steps to calculate capital gain tax includes:
- First, determine the sale value of the property.
- Calculate the selling expenses.
- Get the amount realized by making a difference in sales price by selling expenses.
- Calculate the total basis
- Determine adjusted basis
- Determine whether it’s a gain or a loss by deciding between the amount realized and the adjusted basis.
Home renovations and improvements such as a new roof, carpeting, or ductwork can affect the gain or loss of the profit. You can add these to the calculations but remember that renovations will add value to the house and increase its adjusted basis.
Who Pays Capital Gains Tax?
Many people who ask questions like how do I sell my house fast in Kansas City, tend to forget about taxation. However, some factors can make you eligible for capital gain tax. Below are some of the situations under which you will be required to pay capital gains tax.
- If The Property Wasn’t Your Principal Residence
A home is defined broadly, and it could be a condo or even a houseboat. The property must have been your primary home to be eligible for the capital gain tax. If you are a multiple homeowner, do a facts and circumstances test to ensure the home you sell is recognized as a primary residence by the IRS. The home address in your official documents, such as your driver’s license, tax returns, or voting registration, can strengthen the status of your home.
- When You Have Already Claimed The 250,000 Or 500,000 Exclusions
If you had already taken a claim for another home two years before the sale of this property, you’d be required to pay taxes on your new sale.
- You’ve Owned the House for Less Than Two Years
You are required by the agency to at least have owned the home for two years or more in the five years stipulated before putting it on the market. Luckily, if you are married or filing jointly, only one partner must have met this rule.
- You Are Subject to Expatriate Tax
This is a tax levied by the IRS on people who have relinquished their U.S. citizenship or residency status and are living abroad for an extended period.
- If You Haven’t Lived In The House For At Least Two Years In The Five Years Before Selling It
The IRS will want to confirm that you intended to make the house your home for a certain period, and living there for at least two years will prove it. Fortunately, the agency is flexible, and the 24 months don’t have to be consistent. Additionally, vacations and other temporary absences aren’t considered time away from your house. If you are a person with a disability, in the military, or a foreign service agent, you may get an exception on this stipulation. You can find more on IRS publication 523.
Taxes on capital gains are substantial, and luckily, the Taxpayer Relief Act of 1997 allows leeway to property owners who have met the IRS criteria. Certain situations, such as military deployment, also allow exceptions for capital gain tax. Be sure to understand the tax rules and stay updated on any changes to help you get ready to sell your house. Moreover, consulting a real estate agent can help you stay updated on capital gains tax laws.