For most people, your home is your most significant investment and your biggest asset. So, what happens when it’s time to sell?
Your home is considered a capital asset. Therefore, it’s subject to capital gains tax. However, there are a few exemptions and restrictions to paying taxes on the profit of your home that you should understand. How does selling a home affect taxes? Let’s find out.
Taxpayer Relief Act of 1997
The Taxpayer Relief Act of 1997 exempts most homeowners from paying capital gains tax on the profits from selling their homes. According to the Act, if you sell your primary residence, you are exempt from capital gains taxes on the first $250,000 of profit ($500,000 if married filing jointly).
This exemption has a few rules.
- To qualify as your primary residence, you must have occupied it for at least two of the last five years.
- You can only qualify for the exemption every two years.
- You can use capital losses to offset the capital gains from the sale of your home.
How Capital Gains Tax Works When You Sell a Home
To illustrate how capital gains tax works, take this example. In 2016, you purchased a single-family home for $300,000. You lived there from 2016 – 2018 (two years) and rented it out for the remaining three years. After five years, in 2021, you sell the condo for $500,000. Since your $200,000 does not exceed the exclusion amount, you do not owe capital gains taxes.
In a different scenario, say you sell the condo for $600,000 instead. This means your total profit was $300,000. Here, you would owe real estate taxes on the $50,000 that exceeds the threshold.
When Do You Have to Pay Taxes on the Sale of Your Home?
The Taxpayer Relief Act of 1997 exemptions only apply to your primary residence, so there are other home sale situations in which you will have to pay taxes. Capital gains from your home are fully taxable when:
- It is not your primary residence.
- It was acquired through a 1031 exchange within five years.
- The seller must pay expatriate taxes.
- The seller sold a different home and used the capital gains within two years of the sale date of this home.
Using a 1031 Exchange to Defer Real Estate Taxes in Colorado
A 1031 exchange allows you to defer paying capital gains tax on the sale of your property if you reinvest the proceeds into a new like-kind property.
The 1031 provision applies to investment properties, so you cannot exchange your primary residence. However, this means that if you use the Taxpayer Relief Act of 1997 exemption on the sale of your primary residence (and the capital gains are less than $250,000), you can use a 1031 exchange to sell your investment property and at least defer capital gains tax.
In a deferred like-kind exchange, you have 45 days to designate a replacement property and 180 days to finalize the exchange after the sale takes place. Learn more about 1031 exchanges in Colorado here.
Learn More About Real Estate Taxes on the Sale of Your Home
This article is not meant to dive into great detail about capital gains taxes and 1030 tax-deferred exchanges. Rather, it aims to briefly answer the common question, “How does selling a home affect taxes?”
If you’re selling your home and have further questions about capital gains tax on home sales in Colorado, I encourage you to reach out to a financial professional to see what financial rules apply to you.
The information in this article is fact-checked through the IRS website, but please do not take the information here as your only tax advice. Always consult a tax professional before making any decisions about taxes and exemptions.