6 Ways to Avoid Paying Capital Gains Tax on Your Home Sale

If you’ve owned your house for 7-10 years, your overall home appreciation rate may be as high as 50%. Even if you’ve only owned your property for 2-3 years, it’s likely you’ve built up some healthy equity.

But when you try to cash out on your biggest life investment, the IRS can swoop in to steal your thunder. That’s right… you have to pay taxes when you sell your home (unless you don’t).

The capital gains tax, the tax on the sale of a capital investment, could siphon off up to 20% of your profit. In this post, a leading tax analyst and a top-performing real estate agent break down the nitty-gritty of capital gains tax when you sell your home, so you can walk away with more of your home sale proceeds.

Editor’s note: This article is meant for educational purposes and should not be construed as financial or tax advice. HomeLight encourages you to reach out to a professional advisor regarding your own situation.

Capital gains tax on a home sale explained

Generally speaking, the capital gains tax is the tax imposed on the sale of a capital investment.

Nathan Rigney, a lead tax analyst at H&R Block, explains that real estate property is a capital asset, so it is subjected to capital gains tax once it’s sold. But, there are exclusions that are easy to qualify for if you know about them ahead of time.

“If you’re selling your main home and you’ve lived in it and owned it for at least 2 of the last 5 years, you can exclude possibly all of the gain,” says Rigney.

To break it down, this is how he puts it:

If you’re a single tax filer and you sell your primary home, you can exclude up to a $250,000 gain.
If you’re married and filing jointly, you can exclude up to a $500,000 gain in the sale of your primary home.

But how do I determine my capital gain?

Well, the gain on your sale is, essentially, the profit that you’ve made on the investment.

According to Rigney, this is how you find the capital gain from your house sale:

Calculate your basis. Take the cost you paid for your house and add any improvements you’ve paid for since you’ve owned it (remodeled kitchen, new roof, etc.) Make sure you have the receipts!

Take the price you are selling your home for and subtract your basis to determine your capital gain.

So, if you paid $200,000 for a house and, over the past 10 years of living in it, spent $50,000 to redo the kitchen and fix the roof, your cost basis is $250,000. If you sell it as a joint tax filer for $350,000, your capital gains will be $100,000, and you will not have to pay capital gains tax.

Sounds simple, right?

Just wait; it’s not that cut and dried. A wrong move here or there — like selling your home too soon — can increase your capital gains tax liability, and you want to take advantage of all the tax-free profit you can get.

When do I need to pay capital gains tax on my home sale?

There are a few scenarios in which your capital gain will exceed the tax-exemption threshold. If you’re in the real estate market where prices are increasing rapidly, or if you’ve owned a piece of property for so long that its value has skyrocketed, you might see a gain over that $250,00 or $500,000 cap.

Here, we’ll look at these possibilities more in-depth.

The local real estate market has changed dramatically

If you maintain your house regularly throughout the time you own it, you stand to make a profit when you sell it. And in most cases, your profit will fall under the $250,000 (if single) or $500,000 (if married) threshold of capital gains tax — unless you own a home in a real estate market that has skyrocketed in recent years.

Take San Francisco, for example.

It’s not uncommon for the average selling price of a home in parts of San Francisco to be set at $1.7 million in the current market. Whereas in 2008, the average selling price was $763,000 — a nearly 1 million dollar increase over the past 10 years.

So, theoretically, married homeowners in San Francisco could stand to pay capital gain tax on up to half of their home sale profit.

Chris Carter, who has 29 years of experience and ranks in the top 2% of agents in Jackson County, Missouri, says that in the Midwest, getting hit with capital gains tax isn’t really a problem.

“The only time we really run into it is if somebody lived on a farm or inherited a farm as their primary residence, sold it, and then bought a house in town. They might get hit with some sort of capital gains tax at that point,” Carter says.

If you own a home in a market that has remained relatively steady since the time you purchased your home, you can relax. Your profits will most likely be exempt from the capital gains tax.