How Capital Gains Tax on Home Sales Works

If you sell your home for a profit, the IRS considers this a taxable capital gain. This rule applies to all home sales, including vacation or investment properties. However, if you sell your primary residence, you may be able to exclude $250,000 of gain for individuals and $500,000 for married couples from your taxes. As a result, in most cases, it’s unlikely that you will owe taxes on the sale of your home. Here’s how it works.

Home Sale Exclusion

For the most part, the rules around real estate and capital gains don’t change based on the nature of the underlying property. If you sell a house and make money, that profit is considered a taxable capital gain. 

However, there is a broad exclusion for the sale of your primary residence. When you sell your main home, you are allowed to exclude the first $250,000 single/$500,000 joint of the profits from your taxes. Importantly, this exclusion applies to your gains, so you apply the exclusion after you adjust for the property’s tax basis. So, your math here is:

• Sale Price – (Purchase Price + Qualified Spending) – Exclusion = Taxable Gains

To qualify for the home sale exclusion, otherwise known as the Section 121 Exclusion, you must meet what is known as the “ownership and use” test. This means that you must have owned the property and lived in it as your primary residence for at least 2 out of the past 5 years. This time can be nonconsecutive, but it must apply to the five-year period directly before the sale. The purpose of this test is to limit the home sale exclusion to a primary residence, rather than investments, vacation properties or flips. 

For individuals or couples, this exclusion means that you will typically pay little, if any, taxes on all but the most lucrative sales.

Real Estate Sales and Capital Gains

Real estate sales are considered capital gains, so when you sell a property, you account for any profits or losses on your capital gains taxes. As always, your capital gain from selling the house is your sale price less the tax basis of the property.

Calculating the tax basis for a home sale can get fairly complicated. In general, the IRS allows you to consider any improvements and updates that you’ve made to the property as part of your overall investment, as well as many of the costs involved with marketing and selling the property. However, you cannot include costs for maintenance and repairs, nor can you claim financing costs. So as you own a property over the years, it’s worth keeping a record of any money you spend upgrading and improving it.

In broadest strokes, the IRS defines this difference by classifying improvements as spending that will “add to the value of your home, prolong its useful life, or adapt it to new uses.”

So, for example, say that you sell your home for $1,000,000. Over the years, you spent the following money on the property:

• Purchase Price – $550,000
• Interest on the mortgage – $65,000
• New windows – $8,000
• Deck repairs – $2,550
• Listing and marketing fees – $30,000

You can include your purchase price, the new windows and the marketing fees on your property’s tax basis. You cannot include the deck repairs, since that’s maintenance, nor can you include your interest payments. So, your capital gains here are:

• $1,000,000 – $588,000 (Original purchase price, Windows and Listing-Marketing fees) = $412,000

You would have $412,000 in capital gains. If your total taxable income puts you in the 15% capital gains rate bracket (which is the most common), you will pay $61,800 on that gain (15% x $412,000).

These are the rules that will apply to most property sales. So, for example, say that you have a vacation house or a rental property. If you sell that home, you will calculate your tax basis, then determine your capital gains, then pay taxes on those gains based on your overall tax rates. 

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Remember; To qualify for the home sale exclusion, otherwise known as the Section 121 Exclusion, you must meet what is known as the “ownership and use” test. This means that you must have owned the property and lived in it as your primary residence for at least 2 out of the past 5 years. This time can be nonconsecutive, but it must apply to the five-year period directly before the sale. The purpose of this test is to limit the home sale exclusion to a primary residence, rather than investments, vacation properties or flips. 

Since capital gains are a form of income, they are subject to taxation. However, Congress has established a special, lower rate for long-term capital gains called the capital gains tax. In 2024, there are three long-term capital gains tax brackets:

• 0% – Up to $47,025 Single/$94,050 Joint
• 15% – Between $47,026 – $518,900 Single/Between $94,051 – $583,750 Joint
• 20% – Above $518,900 Single/$583,750 Joint

Bottom Line

If you sell a home, or any other piece of real estate, any profit you make from the sale will be considered capital gains. For any house other than your primary residence, you will pay capital gains taxes on the entire amount. For your primary residence, you can exempt $250,000 per person from your taxes.

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Be sure to ask these important questions before you hire a Broker to help sell your home: 

What You Don’t Know About Hiring a Real Estate Agent Could Cost You.