How to Defer, Reduce or Avoid Capital Gains Tax on Your House Sale
- Author: Bryan Miller
- Posted: 2024-10-09
The basis of selling your house is probably to make a profit. However, in the U.S., the federal capital gains tax often reaches 37%, which means that after the sale, you may not be left with much after paying the tax. Thankfully, it's possible to reduce or defer your capital gains tax exposure and keep a bigger share of the profits.
Here's what you need to do:
Take Advantage of the IRS Tax Exemptions
Tax exclusions are a form of incentive that you can take advantage of to avoid the capital gains tax on your house sale. Thanks to the Taxpayer relief act, you can enjoy an exclusion of $250,000 if you are single and $500,000 if you are a married couple. The only downside to this incentive is that the house must be your primary residence. This means that you must have been living there for at least two years within the last five prior to your sale.
Apart from the exemption, you can add the costs you incurred during the purchase and sale of the property. The purchase costs include the closing price and title insurance. Add these to your selling costs, such as real estate agent and legal fees. The total you get will lower your capital gains. To get your gains tax waived, limit your selling price within that total to waive your tax obligation.
For example, assuming you bought the property for $100,000. After six years, you can sell it for a little over $600,000 if you make the sale as a married couple. In this case, $500,000 will automatically be excluded, while the rest will be deducted through the purchase and sale costs. You cannot be charged tax for $0 recognized gains.
Sell at the Most Convenient Time
The timing for making the sale determines whether you can avoid gains tax. As I mentioned, you cannot enjoy house sale tax exclusions if you have not been living in that house for two years as it cannot be legally considered your permanent residence.
Additionally, you cannot enjoy the Taxpayer Relief if you made a similar sale within the last two years. In either case, you ought to be patient enough to let the two-year holding period lapse. When the time is right, you will be able to sell your house at zero tax.
Reinvest Through 1031 Exchange
The Internal Revenue Code 1031 is a real estate property exchange that allows you to defer gains tax in capital property sales. To benefit, you need to sell the property and reinvest the whole amount in a similar property within 45 days. You can defer the tax since you will not have monetized your sale.
The downside, however, is that this is primarily meant for commercial property. Therefore, you may not be able to sell your house directly through a 1031 exchange. Notwithstanding, this is the loophole you can enjoy. All you need to do is change your house into a rental property for two years before the sale. Note that you can only make it commercial if the zoning laws in your area are in your favor.
This is a good sale option if you are planning to buy a retirement home.
Receive Payments in Installments
While selling your home through code 1031 is not straightforward, selling through an installment sale is much simpler. Installment sale allows you to defer recognizing your gains until the amount is paid in full. A suitable example is the structured installment sale. You will only be required to pay federal income tax on each installment through this type of sale. This is a cheaper alternative to paying the onetime gains tax. Since the installments are in low amounts, the income tax rate will also be lower. This means that you will pay a much-subsidized sum in the long run compared to the outright capital gains tax that you would have paid.
For example, paying your gains tax upfront for $100,000 at a rate of 20% will cost you $20,000. On the Other hand, selling your house for $10,000 worth of installments will cost you $10,000. This is because you will only pay federal tax at a 10% rate. If you are single, you will save $9,975 when paying your federal tax at a rate of 12%.
Defer Gains Tax Through Existing Capital Losses
Declaring your tax returns promptly may help you evade the capital gains tax from your house sale. This is possible if you had declared capital losses from previous capital sales. You can then offset them with the capital gains from your house sale. This is making good use of deductions to reduce the amount taxable from your capital gains. This helps you defer the tax payments from your house sale.
Tax laws allow you to get the most out of the sale of your house as they present you with the opportunity to pay less tax or avoid the tax altogether. You can also defer your capital gains tax to make payments at a later time.
