Do you understand how capital gains tax works? Don’t be embarrassed if not. It’s a complicated topic to grasp, especially when it comes to selling a house. There are so many processes, costs, and variables to understand when you’re trying to sell a house in Memphis or anything else in Tennessee that you can’t be expected to be an expert on all of them. But the more you can understand capital gains tax and what’s so important about it, the more likely you are to make a smart decision when you finally decide how to sell your house, whether you decide to sell on the open market on to a reputable cash home buyer like Fair Cash Deal. Let’s take a closer look at capital gains taxes and how they work when selling a house in Tennessee.
What are Capital Gains?
When you’re selling your house in Tennessee, you’re going to want to be aware of what capital gains are. Capital gains is another phrase to describe the profits that you make on a real estate or property deal. Let’s say you buy a house for $200,000. Then a year later you decide to sell the house and you are able to get $250,000 for it. The $50,000 in profit is capital gains. It’s effectively the difference between the purchase price and the sale price of your house.
Capital gains also apply to stocks, land, or a business. However, for the purposes of our discussion, we’re going to talk about it as profits from a home sale. When it comes to capital gains taxes, it’s important to know the distinction between short-term and long-term.
What is Short-Term Capital Gains Tax?
When it comes to the capital gains tax you’ll pay on the sale of your Memphis or Tennessee house, there are some varying factors. Time of ownership is a major one and depending on how long you’ve owned the house, you’ll pay different capital gains tax rates. You’ll have to check the most recent tax bracket information to know for sure).
If you’ve only had possession of the property for one year or less, you’re going to be responsible for short-term capital gains tax. The short-term capital gains tax rate is equal to the ordinary income tax rate of your current tax bracket.
What is Long-Term Capital Gains Tax?
If you have owned the house for more than one calendar year, then you are going to be responsible for long-term capital gains tax. The long-term capital gains tax rate depends on your taxable income and filing status, but will either be 0%, 15%, or 20%.
Can You Avoid Paying Capital Gains Tax?
The IRS does provide you with ways to avoid paying capital gains on real estate. If you are single, they allow $250,000 of capital gains to be excluded. If you are married and filing jointly, they will allow $500,000 of capital gains to be excluded. So let’s say you bought a Tennessee house for $200,000 10 years ago and sold it today for $500,000. You would make $300,000 in capital gains. If you are married and filing jointly, that $300,000 may not be subject to the capital gains tax. If you are single, $250,000 of that may not be subject to capital gains tax, though the remaining $50,000 would.
We say “may not be subject to capital gains tax” because there are some caveats to those exemptions. They only apply so long as you meet certain criteria. And if you don’t, you’ll have to pay the full capital gains tax on your Tennessee house sale transaction. Those criteria include:
- If the Tennessee house was not your place of residence.
- If you owned the house for less than two years in the five years before you decided to sell it.
- If you didn’t live the house for at least two of the last five years before deciding to sell it (though members of the military and those who are disabled can often bypass this requirement).
- If you have already claimed the $250,000/$500,000 exclusion from a different home sale in the two years prior to this home sale.
- If you purchased the house through a like-kind exchange (i.e. you swapped it with another property) within the last five years.
- If you are subject to expatriate tax (you have renounced U.S. citizenship but still own property here).
What’s the Best Way to Avoid Capital Gains Taxes on a Home Sale
If you’re looking to sell a house in Memphis or elsewhere in Tennessee and you’d rather not pay capital gains tax, there are a few things you can do in the short-term and long-term to make that happen.
First, make sure you live in the house for at least two years. They actually don’t even need to be consecutive years, but make sure you live in the house for two years within a five-year period. If you decide to sell your Tennessee house without living in it for two years, the gains are taxable. Selling in less than a year of ownership is even more expensive because the short-term capital gains tax is then applied. That’s going to be higher than the long-term capital gains tax. So either way, try to stick it out for at least two years.
Next, check to see if you qualify for the exceptions. Even if you have a taxable gain on your home sale, you still might be able to exclude some or all of it due to certain exclusions, such as health reasons, work-related issues, or “an unforeseeable event.” Check IRS Publication 523 and make sure you study the fine print.
Also, keep all your home improvement receipts and records. When the IRS is figuring out the cost basis of your house, it doesn’t just include what you paid when you bought it, it also includes the costs of any improvements you’ve made since you owned it. That can help you out because it will raise your cost basis, which you subtract from the sale price to determine capital gains. So even if you bought the house for $200,000, you could add on the $30,000 you paid to remodel or expand it over the years. If you sell the house for $250,000, you’d only be paying capital gains tax on $20,000 instead of $50,000, a big difference. But you’ll have to be able to prove it so make sure you keep good records on everything.
Finally, you can avoid taxes altogether, along with the hassle involved, simply by working with a cash buyer like Fair Cash Deal. Want to sell your house without worrying about capital gains taxes and other high costs? Contact Fair Cash Deal today and we’ll make you a fair cash offer on your house. We can buy your house in its current condition (as-is) and we can close in a matter of days, depending on how fast you’d like to close. Then you get cash for your house and avoid the drama and headaches.