Thinking about selling a home this spring? The real estate market is heating up, but before you celebrate your big sale, make sure you understand capital gains tax—because the IRS might take a bigger cut than you expect.
Many homeowners assume they don’t have to pay taxes if they reinvest their home sale proceeds into another property. Unfortunately, that’s an outdated myth. The truth is that capital gains tax applies when you sell a home for more than you originally paid, and failing to plan ahead could leave you with an unexpected tax bill.
What Is Capital Gains Tax?
Capital gains tax is a tax on the profit made from selling an asset, including real estate. The taxable amount is the difference between:
- The sale price of the home
- The “cost basis”—which is usually what you originally paid for the home, plus certain qualifying improvements.
For example, if you bought a home for $300,000 and sell it for $600,000, your capital gain is $300,000—which could be subject to tax unless you qualify for an exclusion.
Who Qualifies for the $250K/$500K Capital Gains Exclusion?
The IRS allows homeowners to exclude up to:
- $250,000 of capital gains if they are single
- $500,000 if they are married and filing jointly
However, homeowners must meet the following criteria:
- Ownership Test – You must have owned the home for at least two years.
- Use Test – You must have lived in the home as your primary residence for at least two of the last five years before selling.
This means that even if you rented the home for part of the last five years, you may still qualify as long as you lived in it for two full years during that time.
What Happens If One Spouse Passes Away?
A surviving spouse can still claim the full $500,000 exclusion—but only if the home is sold within two years of their spouse’s death.
After two years, the surviving spouse only qualifies for the $250,000 single filer exclusion, which could result in a much higher taxable gain.
What About Inherited Homes?
If you inherit a home, you typically receive a step-up in basis, which means the home’s new cost basis is its fair market value at the time of the previous owner’s death—not what they originally paid for it.
For example, if your parents bought a home for $100,000 but it was worth $600,000 when you inherited it, your new cost basis is $600,000. If you sell the home for that amount, you owe zero capital gains tax.
This rule helps many heirs avoid or significantly reduce capital gains taxes when selling inherited property.
What About Real Estate Investors?
If you’re selling a rental property or investment real estate, you don’t qualify for the $250K/$500K exclusion—but you can defer capital gains tax using a 1031 exchange.
A 1031 exchange allows investors to reinvest proceeds into another investment property to defer capital gains taxes. This is a powerful tax-saving strategy for those growing a real estate portfolio.
How to Reduce or Avoid Capital Gains Tax When Selling a Home
Here are a few key strategies homeowners can use to reduce or eliminate capital gains taxes:
- Live in the home for at least 2 years – Meet the IRS’s ownership and use test.
- Sell within 2 years if you’re a surviving spouse – This preserves the full $500K exclusion.
- Use a 1031 exchange if selling an investment property – This defers taxes by reinvesting in another property.
- Keep records of home improvements – Upgrades like new roofs, additions, and renovations increase your cost basis, reducing taxable gains.
What Real Estate Agents & Financial Advisors Need to Know
As a real estate agent or financial advisor, helping clients understand capital gains tax before they sell can prevent tax surprises and protect their profits.
Many sellers assume they won’t owe taxes—until it’s too late. A little education upfront can help them make smarter financial decisions this spring.
Have Questions? Let’s Talk!
If you or your clients need guidance on capital gains tax, estate planning, or real estate law, I’m happy to help. Reach out today to get started!
