Tapping your home equity to help pay for a home renovation or a child’s college education might be one of the wisest investments you can make. But there is a wiser investment to consider: tax efficiency.
If you sell your home and make a profit, capital gains tax will apply. The rules surrounding capital gains tax on home sale can be complex, especially when figuring out how to pay that tax. It’s best not to leave this decision to change, but rather read this article and learn the most important aspect of capital gains tax.
What are Capital Gains?
Capital gain is the increase in your net worth or profit you make from the disposal or sale of a capital asset. The capital gain tax starts to apply when some or all of your gain relates to specific investments you made while owning the property (whether you sold it or pocketed the appreciation in cost over time).
For passive investors who do not intend to sell the property or switch to investing in real estate actively, there are no taxes for them. If your property has been holding steady value for several years, there will most likely be little or no change in your gains. However, if your property started appreciating very suddenly, then a capital gains tax could become costly for you.
When Is The Home Sale Taxable?
If you sold your home and both the following apply, the sale is taxable: You owned the home as your principal residence for at least two years. You or your spouse or common-law partner bought another home that is your spouse’s or common-law partner’s principal residence.
How to Calculate?
The way to calculate capital gain on a property is pretty simple. Deduct the initial cost and any expenses you paid when owning the property from the total sales price. These are referred to as “capital expenditures” or “capital expenses.”
For example, if you buy a mansion for $300,000 and sell it for $350,000, you would have made a $50,000 profit. About half of this is taxable, meaning you’ll pay taxes on only $25,000 of it.
How Can You Avoid Paying Capital Gains Tax on Your Home Sale?
- Make sure your home is your primary residence. You can exclude up to $250,000 of gain if you’ve lived in the home for two of the last five years before the sale. That’s $500,000 for married couples.
- Make improvements to the home instead of buying a new home. It will cost you. You have to apply for a tax deduction. However, your primary residence needs to be where you spend the majority of your day.
- Check the tax laws in your area. Consult a tax advisor with tax experience in your area.
Final Words
If you plan on making a significant capital gain or own shares that pay dividends, hiring a wealth manager, a tax specialist, an accountant, or a financial adviser can be worthwhile. An expert will help you decide whether to declare a capital loss or sell declining stocks to offset a benefit at a strategic time.
Alternatively, if you don’t have a consistent income, you may report your gain during the year where your earnings are low, allowing you to take advantage of a lower tax rate on capital gains on a home sale.