While the majority of sellers don’t owe capital gains taxes, high-priced home sales or prolonged ownership can result in a hefty bill, according to experts.
Key Points
- It’s probable that you might have to pay capital gains taxes on the proceeds from the sale of a profitable home in 2022.
- But, if you meet certain IRS requirements, you may be able to exclude up to $250,000 from capital gains as a single seller or $500,000 for married couples filing jointly.
- If your gain exceeds these limits, tax experts advise adding “capital improvements” to the purchase price of your home and deducting selling expenses from your profit.
Despite the market cooling, many homeowners made money in 2022 when they sold their homes; some of that profit might be taxable.
According to ATTOM, a national real estate database, home sellers made an average profit of $112,000 on each typical sale in 2022, a 21% increase from 2021 and a 78% increase from two years prior.
Putting a house up for sale. (Photo: Getty Images/iStockphoto)
This is how it goes: Profits from home sales are treated as capital gains and are subject to federal taxes at rates of 0%, 15%, or 20%, depending on your taxable income in 2022. (You determine “taxable income” by deducting the greater of your standard or itemized deductions from your adjusted gross income.)
If you are a single home seller, you can shield up to $250,000 of your profit from capital gains taxes, and if you are a married couple filing jointly, you can shield up to $500,000, provided you adhere to specific IRS guidelines.
Capital gains tax rates for 2022
| Long-term capital gains rate | Taxable income |
|---|---|
| Single filers | |
| 0% | $0 to $41,675 |
| 15% | $41,676 to $459,750 |
| 20% | $459,751 or more |
| Married filing jointly | |
| 0% | $0 to $83,350 |
| 15% | $83,351 to $517,200 |
| 20% | $517,201 or more |
However, if your home profit exceeds those limits, you might be required to pay capital gains taxes.
For those unaware of it, especially those with significant appreciation and embedded gains, “it can be a pretty sizable tax burden,” according to certified financial planner Anjali Jariwala, founder of FIT Advisors in Redondo Beach, California. She holds certification as a public accountant.
How to be eligible for exemptions of $250,000 or $500,000
According to Mark Steber, chief tax information officer at Jackson Hewitt, most sellers’ profits fall under the $250,000 or $500,000 capital gains exemptions, but there are specific requirements to qualify.
The first requirement is to satisfy the “ownership test,” which stipulates that you must have owned the property for at least two of the five years preceding the sale.
A “residence test” is another requirement, according to which the house had to be your “primary principal residence” for at least two of the previous five years. But according to Steber, “it doesn’t have to be continuous.”
As long as it has been at least two years since your previous claim, he said, “You get this break as many times as you want.”
The IRS has some exceptions to the eligibility requirements, which are outlined here. These exceptions include specific guidance for cases of separation or divorce, widowed taxpayers, service members, and more.
To decrease tax obligations, increase the “basis” of your home.
According to Jariwala, many home sellers are unaware that raising their property’s “basis” (or purchase price) has the potential to lower profits and possibly capital gains.
She explained that you could add on the cost of “capital improvements” and said that the home’s purchase price is the starting point for your basis.
If a homeowner has owned their house for ten years and is selling it, they might still need to make improvements like replacing the roof or installing new floors, according to Jariwala.
She advised that keeping records of all the improvements you’ve made to your house over the years is crucial.
Repairs and upkeep, such as painting or fixing leaks, are only eligible if they increase the value and the house’s lifespan.
In addition, you can deduct selling-related costs like commissions paid to the real estate agent or expenses incurred to prepare the home for sale when figuring out your home’s sales profit, according to Jariwala.
She advised getting organized with receipts now if you intend to sell in the future so you can identify precisely which costs might lower your profits. If not, you might be rushing to determine your basis before the tax deadline.
She warned that you may not have enough time to gather everything you need, in which case you’ll be losing money.
Of course, if you anticipate a sizeable gain, you may also consider the timing of the sale based on your projected income for the year or tax-offsetting leverage strategies. Jariwala continued, “You really have to look at the [tax] return holistically.”
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