Selling a Home? Beware Potential Capital Gains Tax

August 16, 2022
Record-high home prices could mean outsize taxes. Here's how to manage your cost basis to keep your tax liability as low as possible.

Over the past two years, U.S. housing prices soared by more than 32%.1 Though the market is cooling, many home sellers could still see considerable profits—and the resulting tax bill could be significant.

Under current law, you may be able to exclude from your income up to $250,000 in capital gains ($500,000 for married couples) generated from the sale of your home. That means any gains equal to or below those limits will be tax-free so long as you:

  • Owned and used the home as your primary residence for at least two years, in aggregate, of the five years prior to the sale date.
  • Didn't exclude the gain from the sale of another home during the two years prior to the sale of your current home.
  • Didn't acquire the home through a 1031 exchange, in which you defer gains from the sale of an investment property by reinvesting the proceeds in a similar property.

Any profit that doesn't qualify for or exceeds the exclusion will be taxed as a capital gain. Short-term gains, which apply to properties held for one year or less, are taxed at your ordinary tax rate (up to 37%); long-term gains for properties held longer than a year are taxed at 0%, 15%, or 20%, depending on your income. 

"Today's prices mean more home values are approaching those exclusion thresholds, which haven't changed since 1997," says Hayden Adams, CPA, CFP®, director of tax and financial planning at the Schwab Center for Financial Research.

One way to manage a potential tax bill is to take full advantage of the cost-basis adjustments available to you. "Your cost basis, which is used to determine your total gain, isn't just the home's purchase price," Hayden says. "If you paid certain closing costs or made value-adding improvements, you can add those expenses to your basis—and potentially lower your tax bill." (You can find details on acceptable cost-basis adjustments in IRS Publication 523, Selling Your Home.)

Still, it's possible you may realize a taxable capital gain even after applying the personal residence exclusion and adjusting your cost basis. In that case, "you may need to increase your withholding or make estimated tax payments to avoid underwithholding penalties," Hayden says.

1Chris Arnold, "Home prices could fall in some U.S. cities. Here's where and why,", 05/12/2022.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

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Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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