Capital Gains Tax on Real Estate: What You Need to Know

Capital gain is when you profit by selling an asset for more than its original worth. You have to pay income tax on your net profit from these gains.

The amount you owe depends on whether it’s considered a short-term gain, which the IRS treats like regular taxable income at ordinary income tax rates, or a long-term gain, which it taxes at either 20%, 15%, or 0%, depending on your tax filing status, with some exceptions. This tax applies to property purchases, including primary residences and investment properties. 

In this article, we’ll explore capital gains tax and how to avoid it when you sell your assets. 

Key Takeaways

• Capital gains are the profits you make when you sell assets like real estate, investments, stocks, cryptocurrency, and items like boats or cars for more than their original value.
• Your gains are calculated by subtracting the original asset cost or purchase price, called a tax basis, plus expenses from the final sale price you receive.
• Your capital gains can be short-term or long-term, depending on how long you owned the asset before selling it.
• You owe taxes to the IRS for your net capital gains or your net capital profit in the tax year.
• You may be eligible for a $250,000 tax exclusion if the property is your primary residence, you’ve owned the house for at least 2 years, have lived in the house for at least 2 of the past 5 years, and have not used this exclusion on another sale in the past 2 years.
• Rental properties are not eligible for tax exclusions, but you may move into the property for 2 years to take advantage of the primary residence exclusion. 
• If you lose money by selling assets for less than their worth, this is known as a capital loss, which can reduce your liability and offset capital gains and, by extension, your tax burden.

Table of Contents

• What Is Capital Gains Tax on Real Estate?
• Capital Gains Tax on a Primary Residence
• Capital Gains Tax on Rental Property
• How to Avoid Capital Gains Tax on Real Estate
• Streamline Your Real Estate Tax Management With FreshBooks
• FAQs About the Real Estate Capital Gains Tax Rate

What Is Capital Gains Tax on Real Estate?

Capital gains tax is the tax you must pay to the IRS on any profit you make when you sell an asset, including a residential home sale. 

The tax rate depends not only on your income bracket and marital status but also on the time you’ve owned the house and whether it was your primary residence, a secondary home, or an investment property.

If you have owned the property for over 1 year, it’s considered a long-term capital gain. 

If you hold the asset for 1 year or less, this is called a short-term gain. You pay taxes on your sales profits under the same parameters as regular federal income taxes.

Capital Gains Tax on a Primary Residence  

When you sell your primary residence, you’re selling a taxable asset, and you must report your financial gains to the IRS, with taxes paid along with the tax return for the year you sold the home. 

The IRS offers a helpful exception to the rule to reduce the amount homeowners must pay when selling their primary residence. The first $250,000 is tax-free if:

• You’ve been the owner for at least 2 years.
• You’ve lived in the house for at least 2 of the past 5 years.
• You haven’t used this exclusion on another sale in the past 2 years.

The long-term capital gains tax rates for long-term net gains depend on your overall taxable income and are defined by the IRS as follows: 

Long-Term Taxable Income Rates	Single	Married, Filing Separately	Married, Filing Jointly	Head of Household
0%	Less than $44,625	Less than $44,625	Less than $89,250	Less than $57,750
15%	$44,626 to $492,300	$44,626 to $276,900	$89,251 to $553,050	$59,751 to $523,051
20%	More than $492,300	More than $276,900	More than $553,050	More than $523,051

Source: IRS

The rate may also be 25% to 28% in a few exceptions.

Capital Gains Tax on Rental Property 

Capital gains taxes on rental properties are more complex than they are when you sell your primary residence, as there are no capital gains exclusions for rental properties or other real estate investments. 

According to the IRS, if you were entitled to take depreciation deductions, you cannot exclude “the part of your gain equal to any depreciation allowed (actually deducted) or allowable (legally expected to be deducted) as a deduction for periods after May 6, 1997.” This stipulation limits the depreciation-related gain you can exclude from your income taxes. 

Keeping the property for at least 12 months is generally in your best interest. If you sell within a year, the IRS will tax it as ordinary income rather than the lower capital gains tax, which could make the tax rate as high as 37% rather than the lower 0%, 15%, or 20% capital gains rate.  

How to Avoid Capital Gains Tax on Real Estate

Some common ways you can reduce or avoid paying capital gains tax on your real estate investment include:

The 1031 Exchange

The 1031 exchange, also known as a like-kind exchange, is an IRS exception that allows individuals and corporations to reinvest the proceeds of their real estate sale into a similar property. It’s not a tax-free exchange but rather a form of tax deferral.

Use Your Capital Losses to Offset the Gains

A capital loss occurs when you sell assets for less than their worth. Your net capital loss can offset the tax you must pay. 

The amount you can claim is the lesser of $1,500 (or $3,000 if married, filing jointly) or the total net loss showing on Form 1040, Line 16, Schedule D. You can carry forward any extra capital loss to later years. 

Primary Residence Exclusion

As referenced above, you may qualify to exclude up to $250,000 of your gains from taxation (or up to $500,000 if married and filing jointly with your spouse). If you can establish a rental property you want to sell as your primary residence by moving in for 2 years or longer, you can avoid paying a lot in capital gains taxes.

Invest in Opportunity Zones

Some areas deemed “opportunity zones” under the Tax Cuts and Jobs Act of 2017 offer tax incentives like a step up in your tax basis amount after 5 years. These incentives reduce the capital gains taxes you’ll have to pay when you sell. 

Home Improvements

If you spend money improving the home (and save your receipts), you may be able to apply the amount you paid to adjust the initial price of your home, raising the adjusted cost basis. The higher the adjusted cost basis is, the lower your capital gain amount will be when you sell the property. 

Note that these must be home improvements that are upgrades to the property, not repairs or maintenance. 

Ask an Expert

The best way to manage your taxes is to carefully track your income and taxes and consult a professional tax adviser. They’ll be able to point out any laws, exceptions, or legal loopholes you may have missed and keep you on the right track during tax season. 

Streamline Your Real Estate Tax Management With FreshBooks

FreshBooks accounting software helps real estate professionals with invoicing and financial reporting. Features simplify tax preparation by automatically categorizing expenses and generating insightful reports. You can use FreshBooks to track your expenses and purchases—making it easier to file your taxes accurately—share robust financial reports with your accountant (with Plus plans and higher), and more. 

With FreshBooks real estate accounting software on your side, you can focus more on your business and spend less time on paperwork like expense sorting, invoicing, and time management.

Sign up for a trial and try FreshBooks for free to learn how we can help you streamline your business operations and make life easier during tax time. 

FAQs About the Real Estate Capital Gains Tax Rate

Still curious about capital gains on real estate? Check out the frequently asked questions below to learn more about capital gains tax. 

What Is the 6-Year Rule for Capital Gains Tax?

There is no 6-year rule for capital gains tax in the United States, but in Australia, taxpayers can claim a full capital gains exemption on their principal place of residence (PPOR) for up to 6 years on their tax return if they vacate and then rent out the home. 

How Do You Reduce Capital Gains on a Home Sale?

Some of the most common (and legal) ways to reduce capital gains taxes include using the 1031 Exchange, using capital losses to offset your gains, using the primary residence exclusion, investing in opportunity zones, and adding value to the home through renovations and improvements. 

At What Age Do You Not Pay Capital Gains?

In the United States, no age-based criteria prevent you from paying capital gains tax. There used to be a law that allowed people over 55 a one-time capital gains tax exclusion, but it’s no longer in effect. 

Do You Have to Buy Another Home to Avoid Capital Gains?

You don’t necessarily have to buy another home to avoid capital gains. Depending on your income and filing status, your capital gains taxes could be 0% on your primary residence, and homeowners get a $250,000 exemption (or $500,000 for married filing jointly). 

How Long Do You Have to Invest Before Paying Capital Gains Tax?

You must pay capital gains tax on your investment property immediately, but if you hold on to it for less than 1 year, the IRS will tax it at your (likely higher) regular income tax rate. In most cases, you should hold on to real estate for at least 12 months.

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