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A home seller may not owe any capital gains taxes on sale of a principal residence if the transaction qualifies for the Section 121 exclusion. However, under certain circumstances the seller may owe capital gains tax on at least part of the gain. It’s also possible for the entire gain to be taxed as ordinary income, which would likely move the seller into a higher marginal income tax bracket and generate a large tax bill. Whether you owe on $375k in profit will depend on your own circumstances. Some factors determining how much tax will be owed include your filing status and income, as well as the your history of owning and occupying the property.
If you’re preparing to conduct a major financial transaction, consider talking over the tax implications with a financial advisor.
The Section 121 exclusion refers to a portion of the U.S. tax code that lets someone who sells their principal residence avoid capital gains taxes on some of the gain from the sale, subject to a number of requirements.
Filing status determines how much of the sale can be excluded. Home sellers who file their tax returns as single individuals can exclude up to $250,000 of the capital gain across their lifetime. Married couples who file jointly can shelter up to $500,000.
The ownership and residency requirements are met if the seller has owned and lived in the home as their primary residence for at least two out of the previous five years. This means short-term owners, home flippers, non-occupant real estate investors and people who are selling a second or vacation home are not eligible for this exclusion.
You can only use the Section 121 exclusion if you haven’t claimed it in the past two years, and only up to the lifetime limit’s worth of gains.
If you are a single seller and will net $375,000 in capital gains from selling your home, you may be able to protect $250,000 of the gain from income taxes with the Section 121 exclusion. To qualify, you must have owned the home and used it as your principal residents for at least two of the previous five years. You also must not have used the Section 121 exclusion within two years, and you can only use the amount of the lifetime exclusion unused so far.
Assuming the eligibility requirements are met and you have not used any of your lifetime limit before, $125,000 of the $375,000 gain would be subject to capital gains taxes if you file as a single taxpayer. The capital gains tax rate depends on income, filing status and how long you have owned the asset.
Assuming you earn $100,000 of other taxable income annually, $125,000 of the gain would be taxed at a 15% capital gains tax rate, producing a tax of $18,750 on the gain. Some states also tax capital gains, so you’ll need to consider your local tax situation as well.
If you are married filing jointly, you can shelter up to $500,000 of the gain assuming you have not previously used any of your lifetime exclusion. In this case, since your gain is less than the maximum exclusion amount, you would owe no capital gains on the sale.
Another possible scenario is that the seller has owned the home for less than a year. In this case, regardless of income or filing status, the entire gain on the sale would likely be taxed as ordinary income. For a single filer earning $100,000 of other taxable income, adding the $375,000 gain on the home sale would produce taxable income of $475,000. This would put the seller in the 35% marginal tax bracket and result in an income tax bill of approximately $132,000.
Remember, your exact tax liability will depend on your circumstances. Consider using this free tool to match with a financial advisor if you’re interested in personalized guidance.
The amount of the capital gain on an asset sale is calculated by subtracting the cost basis from the sale price. The cost basis includes cash required to purchase the asset, any money required to pay off a mortgage or other loan and certain other outlays. A higher cost basis usually means a lower capital gain amount. A seller may be able to reduce capital gains taxes by ensuring that cost basis is accurately figured.
While the Section 121 exclusion is available only to owner-occupants who meet the residency and ownership requirements, real estate investors may be able to postpone, if not completely avoid, paying capital gains taxes on transactions. This can be done through a 1031 exchange involving the trade of two properties of approximately equal value. In this case, no capital gains taxes will be owed on the transaction, although the tax will eventually be collected when the new property is sold in a conventional transaction.
The capital gains tax owed on a home sale that netted $375,000 could range from zero to more than $100,000, depending on the income and filing status of the seller as well as how long they owned the home and whether they lived in it full time. A married couple that files jointly and had owned and occupied the home for at least two of the previous five years would likely owe no capital gains taxes at all because of the $500,000 exclusion. A single seller in the same situation would have only a $250,000 exclusion and likely owe capital gains taxes on $125,000 of the sale, with the amount of the tax depending on the seller’s other income. If the home had been owned for less than a year, the gain for any seller would likely be taxed as ordinary income, producing the highest tax bill.
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