Selling your home to downsize can make your retirement more financially stable, but if you have a profit on the sale you might owe capital gains taxes. Fortunately, in many cases those selling their primary residence who are single can exclude $250,000 from capital gains taxes, while married couples filing jointly can exclude $500,000. Employing this exclusion can reduce or eliminate capital gains taxes since earnings are unlikely to go beyond those figures, if at all. Some restrictions do apply, however, so it’s best not to assume your gain will be excluded. There are other strategies that you might be able to use, but these may have significant limitations, uncertainties and risks.
Is the Gain on Your Home Sale Taxable?
Selling your primary residence may result in capital gains taxes, but for many people it doesn’t. To determine whether your gain will get taxed, you must first figure out how much gain qualifies to be excluded. The amount of the gain that can be shielded from taxes depends on the filing status you choose when you submit your income tax return.
Single filers can exclude $250,000 and married couples filing jointly can exclude $500,000 of profits on the sale of a primary home. However, to qualify for these exclusions, the sellers must have owned and lived in the home at least two of the five years prior to selling. Also, you can’t have used the exclusion in the previous two years.
If your gain exceeds the exclusion, the amount of the overage will be taxed as capital gains. The amount of tax depends on how long you have owned the home. If you have owned it for more than a year, you’ll likely qualify for long-term capital gains tax rates of 0%, 15% or 20%. The exact rate depends on your income and other capital gains for the year, and the gain on your home sale gets included when figuring that. In this case, a married couple who makes $550,000 in gains on their home sale would likely be subject to the 15% long-term tax bracket, which starts at $47,025 in 2024.
Downsizing in Action
Here’s how this all could play out, looking at three possible scenarios:
- A married couple filing jointly can exclude $500,000 in gains from taxation after the sale. This would leave only $50,000 to be taxed. Because the couple has owned and lived in the home for at least two out of the last five years, long-term capital gains tax rates will apply. The tax bill for the sale alone would be $50,000 at 15%, or $7,500.
- If you aren’t eligible for any exclusion, due to not living in the home two of the previous five years or using the exclusion more recently than two years, then the entire $550,000 will be taxed. If the whole gain of $550,000 is taxed at 15%, the bill would be $82,500.
- For the sake of an example, let’s assume you were single and meet the criteria for the exclusion. In this scenario, you can exclude $250,000 of the $550,000 gain, which leaves $300,000 taxable. The rate will likely be 15%, as the 20% long-term tax bracket starts at $518,900 for 2024. This will result in 15% taxes owed on the $300,000, or $45,000.
While these guidelines apply to federal capital gains taxes, some states also levy capital gains taxes. States tax capital gains in a variety of ways, so you need to check local laws to get an accurate idea of your tax bill.
Another Approach
You may be able to reduce your taxes, even if none or only part of the gain qualifies for an exclusion. This can be done by making sure you accurately figure your cost basis of the house. To do this, add up all the improvements you made to the property. Now add this figure to the property’s original cost and subtract it from the sale price.
If you have previously not fully accounted for your cost basis, this can reduce the amount of the gain and the subsequent taxes you’ll owe. For instance, if you spent $50,000 on a kitchen renovation and hadn’t included that in your cost basis, accounting for it correctly could reduce your $550,000 gain to $500,000.
Bottom Line
A home seller pocketing $550,000 can legally avoid some capital gains taxes through an exemption and other legitimate tax minimization strategies. However, limitations are abound, so consult a financial advisor to understand how these situations work and how to plan for them.
Retirement Tax Tips
- A financial advisor can help you plan for taxes and retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s income tax calculator can shine a revealing light on how much you’ll owe or receive as a refund next time you file taxes.
Photo credit: ©iStock.com/svetikd, ©iStock.com/pcess609
FAQs
Fortunately, in many cases those selling their primary residence who are single can exclude $250,000 from capital gains taxes, while married couples filing jointly can exclude $500,000. Employing this exclusion can reduce or eliminate capital gains taxes.
What is a simple trick for avoiding capital gains tax on real estate investments? ›
Use a 1031 exchange for real estate
Internal Revenue Code section 1031 provides a way to defer the capital gains tax on the profit you make on the sale of a rental property by rolling the proceeds of the sale into a new property.
How do you avoid capital gains tax when downsizing? ›
You may avoid capital gains taxes on the sale of a residence by using what is known as a “Capital Gains Bypass Trust”. It's not a Living Trust. This tool allows you to sell an appreciated asset, pay zero tax, then manage the sale proceeds in the trust to provide income for you and your spouse for your lifetimes.
How to avoid capital gains when selling a house? ›
Yes. Home sales can be tax free as long as the condition of the sale meets certain criteria: The seller must have owned the home and used it as their principal residence for two out of the last five years (up to the date of closing). The two years do not have to be consecutive to qualify.
How to avoid capital gains tax over 65? ›
Utilize Tax-Advantaged Accounts: Tax-advantaged retirement accounts, such as 401(k)s, Charitable Remainder Trusts, or IRAs, can help seniors reduce their capital gains taxes. Money invested in these accounts grows tax-free, and withdrawals are not taxed until they are taken out in retirement.
At what age do you not pay capital gains? ›
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.
Where should I put money to avoid capital gains tax? ›
Investing in retirement accounts eliminates capital gains taxes on your portfolio. You can buy and sell stocks, bonds and other assets without triggering capital gains taxes. Withdrawals from Traditional IRA, 401(k) and similar accounts may lead to ordinary income taxes.
What is the capital gains tax on $750,000? ›
You would likely be subject to the following capital gains taxes: Profit from sale: $750,000. Taxable gain after exclusion: $250,000. Capital gains rate: 23.8% (including NIIT)
Do I have to buy another house to avoid capital gains? ›
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.
How to pay 0 capital gains tax? ›
Capital gains tax rates
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.
It depends on how long you owned and lived in the home before the sale and how much profit you made. If you owned and lived in the place for two of the five years before the sale, then up to $250,000 of profit is tax-free. If you are married and file a joint return, the tax-free amount doubles to $500,000.
How much do you pay the IRS when you sell a house? ›
If you sell a house or property in one year or less after owning it, the short-term capital gains is taxed as ordinary income, which could be as high as 37 percent. Long-term capital gains for properties you owned for over a year are taxed at 0 percent, 15 percent or 20 percent depending on your income tax bracket.
Does selling a house count as income for social security? ›
Income limitations: Selling your home does not directly impact your eligibility for Social Security benefits. However, if you earn income from the sale, it could potentially affect the taxation of your benefits or eligibility for certain assistance programs.
What is the one time capital gains exemption? ›
If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse. Publication 523, Selling Your Home provides rules and worksheets.
How much can a 70 year old earn without paying taxes? ›
For retirees 65 and older, here's when you can stop filing taxes: Single retirees who earn less than $14,250. Married retirees filing jointly, who earn less than $26,450 if one spouse is 65 or older or who earn less than $27,800 if both spouses are age 65 or older. Married retirees filing separately who earn less than ...
How to calculate capital gains when selling a house? ›
As with other assets such as stocks, capital gains on a home are equal to the difference between the sale price and the seller's basis.
Can you reinvest real estate capital gains to avoid taxes? ›
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.
What is the 2 of 5 rule for capital gains? ›
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.
What is the 6 year rule for capital gains tax? ›
Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.
