Real Estate Capital Gains Tax: Are You Liable on Your Home’s Sale?

What is real estate capital gains tax?

Real estate capital gains tax is the cut the IRS wants when you sell any real estate for a big profit — including your home. But, thanks to tax deductions, allowances, and exclusions, only homeowners making very substantial profits are likely to face a federal tax bill.

Cornell Law School defines capital gains tax thus:

“Capital gains refers to profits gained from the sale of capital assets. This includes a home, personal-use items like household furnishings, vehicles, or intangibles such as stocks or bonds held as investments. When you sell a capital asset, the difference between the cost in the asset (known as the adjusted basis) and the amount you realized from the sale is either a capital gain or a capital loss.”

In this article (Skip to...)

• How does capital gains tax work?
• Calculating capital gains tax
• Short-term vs long-term capital gains
• How to minimize capital gains tax
• Capital gains tax FAQ

How does capital gains tax work?

So, capital gains tax (CGT) applies when you sell a significant asset for a substantial profit. You may have to pay a portion of that profit to the federal government.

When selling a home, you begin with the sale price and deduct from that the original purchase price and the costs of any home improvements for which you have receipts. The difference between the sale price and the “adjusted basis” (the purchase price plus improvement costs) is your potential taxable amount.

Section 121 exclusion

However, we’ll explore in following sections are tax exclusions and allowances that mean most homeowners actually pay nothing in real estate capital gains tax when selling their principal residence. That’s because the median home sales price is currently lower than the Section 121 exclusion that most taxpayers filing jointly can claim.

We’ll dig deeper into that in a minute. But it’s worth noting that the exclusion is only claimable on a property that you both own and occupy. Or, at least, one that you’ve owned and occupied for at least two of the five years before your sale date.

That rule may be suspended if you’re a service member on qualified official extended duty. And the two-year period can be reduced to 12 months if you have become physically or mentally unable to care for yourself.

So, you won’t be able to take the exclusion on vacation or investment properties unless you meet that occupancy rule. You should bear that in mind if you ever have to decide between selling your home or renting it out.

One more thing: When you transfer a home or your interest in a home to your spouse as part of a divorce settlement there’s no CGT liability.

Real estate CGT at the state level

Your state government might want a cut of the profit you make on your home, too. However, not if you live in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming, none of which raised real estate capital gains tax when this was written in 2023. Capital gains tax rates and rules vary from state to state, with California charging the highest at 13.3% on taxable profits.

Unfortunately, we can only discuss federal CGT in this article. Trying to lay out all the different rules and rates for the 41 states that do impose such a tax is too complicated for a single article.

Calculating real estate capital gains tax

We’ve already explained the basis for calculating your potential CGT liability. But let’s work through an example based on median home sales prices.

Let’s say you bought your home during the first quarter of 2000 for the then-median price of $165,300. You sold it during the second quarter of 2023 for the then-median price of $416,100. You have receipts for home improvements (they must have added value to the home for at least one year) that have been carried out over the years totaling $100,000.

The formula is:

• Sales price - (purchase price + home improvements) = potential CGT liability

Drop in the numbers and you get:

• $416,100 - ($165,300 + $100,000) = $150,800

So, you made a capital gain of $150,800. However, the Section 121 exclusion is $250,000 for a single person or a married one filing separately. It’s $500,000 for a married couple filing jointly. So, you wouldn’t pay a cent in federal CGT. Both those capital gains tax exclusion amounts were applicable in 2023.

Nearly all homeowners meet the requirements to claim the Section 121 exclusion. But read this IRS article if you’re worried that your circumstances are complicated and may mean you don’t. Scroll down to the section heading, “Does the Sale of Your Home Qualify for the Exclusion of Gain?”

Short-term vs long-term capital gains tax

The IRS counts a short-term capital gain as one accumulated over a single year: you’ve owned the asset for 12 months or less. Any longer, and it’s a long-term capital gain.

You’ll pay a higher CGT rate on short-term capital gains: up to 37% of your taxable profit depending on your income. But the IRS wants a maximum of 20% (again only if you’re in a high income tax bracket) on a long-term gain. Here are the details:

The tax rate on short-term capital gains is the same as the one you pay on wages and other ordinary income. These rates range from 10% to 37%, depending on your taxable income.

2024 Short-Term Capital Gains Tax Rate Income Thresholds (Taxes Due 2025)

2024 Long-Term Capital Gains Tax Rate Income Thresholds

How to minimize capital gains tax

Chances are, you won’t need to minimize your real estate capital gains tax liabilities. That generous Section 121 exclusion means most people have no such liability.

However, suppose your home is worth millions. You still get that exclusion but it might not be enough to cover your entire profit. Or perhaps you’re selling a vacation home or investment property.

CGT efficiency ideas

In what ways might you be able to reduce the IRS’s cut of your profits? Here are some ideas:

1. Keep all receipts, statements and other documentation relating to improvements you’ve made to the property. They count toward your adjusted basis (see above).
2. Consider moving into the vacation or rental property for a couple of years so it becomes your principal residence, which enables you to claim the Section 121 exemption. But you can’t do that more than once in any two-year period. And it must have been your primary residence for two years (excluding vacations and not necessarily in one continuous period) within five years of your sale date.
3. Immediately reinvest the proceeds of the sale into a different investment property worth as much as or more than the one you’ve sold (a “1031 exchange known as a like-kind exchange”). Your CGT liability is postponed until you sell the new place — unless you do the same again.
4. Delay some of your CGT liability to future years. You may be able to do this if you agree on an installment sale, meaning some of the proceeds will be paid to you in future tax years. But, ultimately, you still have to pay the full amount that would have been due with a normal sale.
5. Sell at a loss. That’s not as crazy as it sounds. If one year you need to reduce your overall CGT liability for tax purposes, reporting a capital gains loss can help. Of course, it’s best done when the investment property you sell is deteriorating in value and is something you wish you’d never clapped eyes on.
6. Claim you’re an exception. The IRS can be sympathetic if your move has been forced by your deteriorating health, a work requirement or some unforeseeable event.

Some of these could make a real difference to your tax bill.

Zombie exemptions

Note that some historical reliefs are no longer available. For example, a measure that once exempted those over 55 years from real estate capital gains expired more than 25 years ago.

Similarly, an exemption that used to apply to gains made on properties in empowerment zones does not apply to sales in tax years beginning after December 31, 2020.

Note: The Mortgage Reports is not a tax website. All the information provided is intended to be for general guidance only. Check the relevant Internal Revenue Service (IRS) rules with a qualified tax professional to ensure they apply in your personal circumstances.

Capital gains tax FAQs

How much is capital gains tax on real estate?

For most, it’s zero. But for those who have made big profits on their homes or who are selling a vacation or investment property, it will depend on how big that profit is, how long you’ve owned the asset, and your income bracket.

When do I pay the capital gains tax on real estate?

You must declare your home’s sale in your IRS tax return for the tax year when it occurred. You must then pay any CGT due the following spring when all that year’s taxes are payable.

How do I avoid capital gains tax on real estate?

Your first step is to keep all the receipts and documentation you get concerning home improvements you make. These should reduce your CGT liability. Other than that, we list CGT efficiency ideas, above.

What are the $250,000 and $500,000 home sale exclusions?

This is the Section 121 exemption (see above). As long as you’ve owned and occupied the home “for a period aggregating at least two years out of the five years prior to its date of sale” (© IRS), you can normally exclude the first $250,000 of your profit if you’re a single filer and $500,000 if you’re married and filing jointly.