In real estate, a capital gain is realized once a property is sold. Fortunately, many homeowners in the United States will be exempt from the capital gains tax if they decide to sell. A homeowner selling their primary residence can attain a maximum profit of $250,000 without being taxed, and married couples can profit up to $500,000 without being taxed, so most property sellers will not be required to pay capital gains taxes unless they reap an enormous profit. This tax exemption is only applicable to property owners who have lived in their homes for a minimum of two years out of the past five years.
Prior to the passage of the Taxpayer Relief Act of 1997, sellers had to reinvest their capital gain into another home inside of two years to avoid being taxed. Property owners age 55 and up were able to keep a maximum of $125,000 from their capital gain without it being taxed, and they were only allowed to do this once in their lives. The passage of this bill gave homeowners more autonomy over their untaxed capital gains, because they were no longer required to put the money into another property almost immediately. There is also no cap on the amount of times an individual or couple can take advantage of this particular tax exemption, so these tax-free gains can be attained each time a home is sold.
Requirements for Capital Gains Tax Exemption
A property must be the owner’s primary residence to qualify for the capital gains tax exemption. Rental properties, vacation homes, and parcels of land are not eligible for the exemption. The primary residence must have been lived in for a minimum of two years within the five-year period before its sale.
The capital gains tax exemption usually does not apply to rental properties, but there is one exception called a 1031 exchange that allows rental property owners to avoid being taxed on their gains. The rental property owner must reinvest the profit from their sale into a like-kind property inside of 180 days.
In a 1031 exchange, the property owner secures a purchase agreement with a buyer and then transfers their ownership of the property to an individual known as a Qualified Intermediary. The Qualified Intermediary then makes the sale to the buyer and keeps the profit until the previous owner finds another property to invest in. Once the sale price is negotiated, the Qualified Intermediary uses the profit to buy the new property and then transfers ownership to the original investor.
Particulars for Married Couples
Married couples looking to benefit from the capital gains tax exemption have a couple special requirements to meet. Only one individual is obligated to have owned the property for a minimum of two years. So even if an unmarried couple lives in a house for a year and starts filing jointly after getting married at the one-year mark, the couple will still be eligible for the tax exemption as long as they reside in the home for another year.