For homeowners, there are many tax considerations. A homeowner is responsible for paying real estate taxes from the moment they purchase their home until the day they sell it.

It's important to know how capital gains tax will impact the sale of your home, even though it may not be the most exciting part of the process. In this article, we're going to explain what capital gains tax is, what it means and how it can reduce your tax burden when you sell your home.

Capital Gains Tax On Real Estate

When an investor sells an investment, he or she has to pay capital gains tax on the profit. Investment sale tax is due in the tax year in which it is sold. Based on the income of the filer, long-term capital gains tax rates will be 0%, 15%, or 20% for the 2022 and 2023 tax years. Annually, the income brackets are adjusted.

If an investor owns an investment for at least one year, he will need to pay long-term capital gains tax on the profits. Investors who own an investment for less than one year are subject to short-term capital gains tax. A taxpayer's short-term tax rate depends on his or her ordinary income bracket. Except for the highest-paid taxpayers, that is a higher tax rate than capital gains.

How Does Capital Gains Tax Work?

Let's start by explaining how the tax works.

Capital gains tax only applies after you sell an asset. Consider the case where you bought your home two years ago and the value has increased by $10,000 since then. The tax isn't due until you sell the property.

For instance, you bought your home for $150,000 and sold it for $200,000. Having a profit of $50,000 (the difference between the two prices) is a capital gain, and it's taxable.

As an example, your home's purchase price determines its cost basis in the property. Let's say you spent $50,000 on a kitchen renovation. Since this is a capital improvement, your cost basis has now increased to $200,000. In other words, that's $150,000 for the original purchase price and $50,000 for the capital improvement). After renovating your home for $200,000, your profit is $0, so there is no capital gains tax.

Most taxpayers pay a higher rate on their income than on any long-term capital gains they may have made. It provides a financial incentive to hold investments for at least a year, after which the profit tax will be lower.

Anyone trading online should be aware that profits they make from buying and selling assets held for less than a year are not just taxed but taxed at a higher rate than profits from long-term assets.

It is possible to reduce capital gains for the year by the total capital losses incurred. Therefore, you are required to pay taxes on your net capital gains. The maximum amount of net losses reported per year is $3,000, but leftover losses can be carried forward.

Capital Gains Tax Rates

Taxes are generally applied to profits from assets sold less than a year after they are purchased as if they were wages or salaries. The gains are added to your earned income or ordinary income on your tax return.

The same is true for dividends paid out by assets, which represent profits even though they aren't capital gains. U.S. taxpayers in the 15% tax bracket and higher are taxed on dividends as ordinary income.

Capital gains made over a long period of time are subject to a different tax system. Taxes on assets held for more than a year and sold for a profit vary according to a rate schedule based on the taxpayer's taxable income. Each year, the rates are adjusted for inflation.

Following are the tax rates for 2022 and 2023:

2022 Tax Rates for Long-Term Capital Gains

Filing Status	0%	15%	20%
Single	Up to $41,675	$41,675 to $459,750	Over $459,750
Head of household	Up to $55,800	$55,800 to $488,500	Over $488,500
Married filing jointly and surviving spouse	Up to $83,350	$83,350 to $517,200	Over $517,200
Married filing separately	Up to $41,675	$41,675 to $258,600	Over $258,600

Listed above are the tax rates for profits from long-term taxable assets.

2023 Tax Rates for Long-Term Capital Gains

Filing Status	0%	15%	20%
Single	Up to $44,625	$44,626 to $492,300	Over $492,300
Head of household	Up to $59,750	$59,751 to $523,050	Over $523,050
Married filing jointly and surviving spouse	Up to $89,250	$89,251 to $553,850	Over $553,850
Married filing separately	Up to $44,625	$44,626 to $276,900	Over $276,900

Listed above are the tax rates for profits from long-term taxable assets.

As shown in this table, long-term capital gains are taxed at lower rates than individual income.

Exceptions And Special Rates For Capital Gains

Certain types of assets are treated differently when it comes to capital gains taxes.

Collectibles

Collectibles, such as art, antiques, jewelry, precious metals, and stamp collections, are taxed at a 28% rate regardless of income. If your tax bracket falls below 28%, you will still be charged this higher rate. Capital gains taxes will be limited to 28% if you're in a higher tax bracket.

Owner-Occupied Real Estate

Real estate capital gains are taxed differently if you sell your principal residence.

Individuals who sell a home and gain $250,000 in capital gains are not subject to income taxes ($500,000 for married couples filing jointly). It applies to sellers who have owned and lived in the home for two years or more. Unlike other investments, capital gains from the sale of a home or other personal property are not deductible from gains.

A taxpayer who bought a house for $200,000 and sold it for $500,000 made a profit of $300,000. Capital gains tax begins after the $250,000 exemption has been applied, so the person must report a capital gain of $50,000. Most home improvements and repairs can be included in the cost of the home, thus reducing taxable capital gains.

Investment Real Estate

Investors who own real estate can often deduct depreciation from income to reflect the continuous deterioration of the property over time. It indicates that the home's physical condition has declined, and its value has not changed in the real estate market.

In essence, depreciation reduces what you're considered to have paid for the property in the first place. It can increase your taxable capital gain if you sell the property. Due to this, the gap between the property's value after deductions and its sale price will be more significant.

A building that costs $100,000 but can be depreciated for $5,000 will be taxed at $95,000. In a real estate sale, the $5,000 is treated as recapturing depreciation deductions.

A recaptured amount is taxed at a rate of 25%. Thus, if the person sold the building for $110,000, there would be a total capital gain of $15,000. It would result in $5,000 of the sale figure being treated as a recapture of the deduction from income. The recaptured amount is taxed at 25%. Depending on the investor's income, the remaining $10,000 of capital gain would be taxed at 0%, 15%, or 20%.

Investment Exceptions

Another levy, the net investment income tax, may be imposed if your income is high. You are taxed an additional 3.8% on your investment income, including capital gains, if your modified adjusted gross income or MAGI  (not your taxable income) exceeds certain thresholds.

The threshold amounts are $250,000 if you are married and filing jointly or surviving a spouse; $200,000 if you are single or head of household; and $125,000 if you are married and filing separately.

How Do Investment Properties Affect Capital Gains Taxes?

You can minimize your burden by selling your investment property strategically. In the world of investment properties, there is no equivalent to the capital gains tax exemption for homes.

Reinvest Sale Proceeds

It is common for real estate investors to engage in 1031 exchanges (like-kind exchanges). Real estate investors who participate in a 1031 exchange sell their current property and roll the proceeds over into a new investment opportunity, postponing their capital gains taxes indefinitely.

A longtime real estate investor with large capital gains tax liabilities may also consider transferring those assets into an opportunity zone. Five years after investing, investors begin to enjoy a step up in basis. Gains are exempt from tax after ten years.

Offset Capital Gains With Capital Losses

In much the same way that individuals might sell their homes when their income is at its lowest ebb, businesses should reduce capital gains by reducing capital losses.

Deduct The Costs Incurred By The Sale

In addition, you can deduct any repairs or renovations you made to an investment property to improve its sale price. You should keep documentation  such as bills, deeds, credit card statements, and other similar documents to prove how much you spent. Having these documents on hand will prove useful if you are audited.

Real Estate Capital Gains Tax FAQs

Find more information about the capital gains tax on real estate properties by reviewing the following frequently asked questions.

What is the deadline for paying capital gains tax on real estate?

Capital gains tax is paid when you sell your property if you are required to do so. Your current tax bracket, how long you've owned and occupied the house, and whether it's your primary residence influence your capital gains tax. To determine when you must pay the capital gains tax and if you qualify for an exemption, check the IRS requirements.

Is it possible to avoid capital gains tax on real estate?

You can avoid capital gains taxes on the first $250,000 for single filers and $500,000 for married filers if you have owned and occupied the property for at least 2 of the last 5 years. Learn more about the capital gains tax exemption through the IRS website.

Should I pay capital gains tax on the sale of a second home or rental property?

Rental properties and second homes may be subject to capital gains tax because they are considered assets. There are also ways to avoid paying taxes on these types of properties, especially if their value has increased recently.

Before selling your rental property or second home, you can turn it into your primary residence. A property can be considered a primary residence  if you have lived in it for at least two years. You can always re-establish your main residence after selling this property.