If you purchase a home and its value increases, selling it within a year means the IRS will treat your profit as short-term capital gains, taxed as ordinary income.
Depending on your tax bracket, the rate may reach 37%.
When capital gains become tax-free
If you have owned the home for at least two years and meet IRS requirements for a primary residence, you may be eligible to exclude some or all of your gains from taxation.
The exclusion limit is $250,000 for single filers and $500,000 for married couples filing jointly.
If your spouse has passed away, you may still qualify for the $500,000 exclusion as a single filer if you meet all the following conditions:
- The sale happens within two years of your spouse’s passing.
- You haven’t remarried at the time of the sale.
- Neither you nor your late spouse used the exclusion on another home sold within the past two years.
- You meet both the two-year ownership and residency requirements.
How do primary residence rules apply when you own multiple homes?
You may have only one principal residence, which is the only property eligible for the capital gains exclusion. The primary rule is the “two out of five years” test: if you lived in the home for at least 730 days within the five years before the sale, it qualifies. The 24 months do not need to be consecutive.
If you’re married and want to claim the full $500,000 exclusion, both spouses must meet the residency rule, even if only one owns the home. You can also use capital losses from the same year to offset gains from your home. This exclusion may only be used once every two years
What about investment properties or second homes?
If you sell a rental or investment property, the exclusion does not apply, even if you used the property for personal purposes for a short period. However, you may still offset these gains with capital losses from the same year.
If you convert a second home into your primary residence, you may qualify for a partial exclusion, but only for the period when the property served as your main home. Gains accrued while it was a rental or investment property do not qualify.
Consider installment sales to manage the tax burden
An installment sale can help reduce your capital gains tax liability. Instead of receiving the full profit at once, you receive payments over a specified period. This spreads the gain into smaller taxable amounts, which can lower your total tax bill compared to getting a lump sum. The length of time you owned the property still determines whether the gains are short-term or long-term.
Final thoughts
This is a general overview, and capital gains from real estate sales can be complex, particularly with significant amounts involved. It’s essential to work with a tax professional who understands your specific situation and can help you structure the sales appropriately. Reach out to our team with any questions.
