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

Selling your home can be a major financial milestone—but it can also trigger capital gains tax if your property has increased in value. Understanding how capital gains work, available exclusions, and tax planning strategies can save you thousands. This guide breaks it down for homeowners.

What Are Capital Gains Taxes?

Capital gains tax is a tax on the profit you make from selling an asset, such as a home. Your gain is calculated as:

Selling Price − Adjusted Basis = Capital Gain

Adjusted Basis: Original purchase price + qualifying home improvements (e.g., adding a bathroom, renovating a kitchen, installing a new roof)
Selling Expenses: Real estate commissions, legal fees, title insurance, and other transaction costs

Short-term vs. long-term gains:

Short-term: Owned ≤ 1 year; taxed at ordinary income rates (up to 37%)
Long-term: Owned > 1 year; taxed at 0%, 15%, or 20% depending on income

Most homeowners qualify for long-term gains rates.

The Primary Residence Exclusion: Your Biggest Tax Break

There are a number of ways you can potentially reduce the amount of capital gains tax you’d have to pay on your property sale. For instance, if your property is your primary residence, you can exclude a significant portion of capital gains under the primary residence exclusion. There are also exceptions for other unforeseen circumstances.

In most cases, your biggest exlusion will come from the property being your primary residence. For your property to qualify as your primary residence, it must pass two tests:

Ownership Test: Have you owned the property for at least 2 of the last 5 years? (if you’re married, only one spouse must meet ownership)
Use Test: Have you lived in the home as your primary residence for at least 2 of the last 5 years.

If you’ve passed both of those test, then you can exclude up to $250,000 (single) or $500,000 (married filing jointly).

Other notable exlusion include:

Job relocations: You may qualify for an exclusion if you have to relocate more than 50 miles due to work.
Health reasons:
Unforeseen circumstances: There are many circumstances that a homeowner has no control over. Things like death, acts of god like natural disasters, divorce, or unemployment may exclude you from capital gains tax.

It’s important to note that your primary residence exclusion can only ever be claimed once every 2 years due to the nature of the tests.

Calculating Your Taxable Gain

To calculate your taxable gain:

Start with the selling price
Subtract selling costs
Subtract adjusted basis (purchase price + capital improvements)

Example:

Purchase price: $300,000
Improvements: $50,000
Selling price: $500,000
Selling expenses: $30,000

Taxable gain = $500,000 − $30,000 − $350,000 = $120,000

This amount may be fully or partially excluded depending on your eligibility.

Current Capital Gains Tax Rates

For long-term gains in 2023:

0%: Single <$44,625; Married <$89,250
15%: Single $44,625–$492,300; Married $89,250–$553,850
20%: Single >$492,300; Married >$553,850

State taxes may apply, ranging from 0% in states like Florida to over 10% in states like California and New York. High-income earners may also face a 3.8% Net Investment Income Tax.

Partial Exclusions for Special Circumstances

If you sell before meeting the 2-year requirement, partial exclusions may apply for:

Job relocations (≥50 miles farther from the former workplace)
Health reasons
Unforeseen circumstances: divorce, natural disasters, death, unemployment

The exclusion is proportional to the time you lived in the home relative to the 2-year requirement.

Inherited and Gifted Property

Inherited property: Taxed on a stepped-up basis (market value at death), minimizing capital gains
Gifted property: Uses the donor’s original basis, which can result in higher taxable gains

Estate planning can leverage these rules to minimize taxes for heirs.

Common Misconceptions

Age 55 exclusion: No longer exists; replaced by the $250,000/$500,000 rule
Reinvestment requirement: Not needed to claim the exclusion
Primary residence designation: Must genuinely live in the home for 2 of the last 5 years

Tax Planning Tips for Homeowners

Timing your sale: Wait to meet the 2-year requirement or adjust the year of sale to minimize tax rates
1031 exchanges: Available for investment properties, not primary residences
Converting rentals to primary residence: Can qualify for partial exclusion after living there 2 years
Tracking improvements and expenses: Increases adjusted basis, reducing taxable gains

Documentation You Need

Keep records of:

Home improvements and receipts
Purchase and sale closing statements
Utility bills, tax returns, and insurance showing primary residence
Chronological timeline of ownership and occupancy

Maintain these for at least 3–6 years after filing.

When to Consult a Tax Professional

Seek advice if you have:

Rental property conversions
Inherited or trust-held properties
Divorce or separation-related sales
Significant home improvements or business use

A CPA or tax attorney with real estate expertise can help maximize tax savings and ensure compliance.

Conclusion: Capital gains taxes on real estate can be complex, but with careful planning, record-keeping, and understanding of exclusions, homeowners can significantly reduce or even eliminate their tax liability. Whether it’s timing your sale, claiming the primary residence exclusion, or leveraging special circumstances, being informed pays off.

Frequently Asked Questions About Capital Gains Tax on Real Estate

1. How do I avoid paying capital gains tax when selling my home?
You may qualify for the primary residence exclusion, which allows you to exclude up to $250,000 (single) or $500,000 (married filing jointly) of profit if you’ve lived in the home for at least 2 of the past 5 years. Timing your sale, tracking home improvements, and consulting a tax professional can also help reduce or eliminate taxes.

2. Do I have to buy another house to avoid capital gains tax?
No. The old “rollover rule” that required reinvesting your sale proceeds into another home was eliminated in 1997. Today, you only need to meet the IRS ownership and use tests to qualify for the exclusion.

3. What if I sell my home before living there for two years?
You may still qualify for a partial exclusion if you sell early due to job relocation, health reasons, or unforeseen circumstances like divorce, natural disaster, or job loss.

4. How much capital gains tax will I pay on my house sale?
That depends on your taxable gain after exclusions and your income bracket. For most homeowners in 2023, long-term capital gains are taxed at 15%, but some pay 0% or 20%. State taxes may also apply.

5. Is inherited property taxed differently?
Yes. Inherited property benefits from a stepped-up basis—the home’s market value at the time of death—so heirs only pay tax on gains after that value. This usually results in little or no tax when the property is sold shortly after inheritance.

6. Do home improvements reduce my capital gains tax?
Yes, but only qualifying improvements that add value or extend the life of the home (e.g., new roof, kitchen remodel, room addition). Routine maintenance and repairs do not count.

7. Should I hire a tax professional before selling my home?
If your sale involves large profits, rental conversions, inherited property, divorce, or business use of the home, consulting a real estate-focused CPA or tax attorney is highly recommended to ensure you maximize exclusions and avoid errors.

As a leading “We Buy Houses in Richmond, VA” company, we are positioned to help you Work through the different options when selling a home. Contact us today to discover how we can transform your home-selling journey right here in Richmond.