Capital Gains Tax
Tax on profit from selling property; reduced rate for long-term investments (>1 year in US).
Key Takeaways
- Capital gains tax is paid on the profit from selling assets like real estate
- Long-term rates (held ≥1 year) are much lower than short-term rates
- US primary residence exclusion: $250k for single / $500k for married couples
- 1031 Exchange allows indefinite deferral of capital gains tax for investment properties
What is Capital Gains Tax?
Capital gains tax is a tax on the profit (or "gain") you make when you sell a capital asset, such as real estate, stocks, or bonds. Think of it this way: if you buy a house for $200,000 and sell it later for $300,000, your capital gain is $100,000. You would owe tax on that $100,000 profit.
This tax applies to most types of property sales, but there are important exemptions and special rules, especially for primary residences and investment properties.
Short-Term vs Long-Term Capital Gains
The tax rate you pay depends on how long you owned the property:
Short-Term Capital Gains
If you sell property you've owned for one year or less, it's considered a short-term gain. These gains are taxed at your ordinary income tax rate, which can range from 10% to 37% in the US. This is the same rate you pay on your salary or wages.
Long-Term Capital Gains
If you sell property you've owned for more than one year, it's considered a long-term gain. These gains enjoy preferential tax rates that are significantly lower than ordinary income rates. In the US, the long-term capital gains tax rates are 0%, 15%, or 20%, depending on your income bracket.
Source: IRS Topic No. 409 Capital Gains and Losses
US Tax Rates for 2024
- Short-term: Taxed at ordinary income rates (10% - 37%)
- Long-term: 0%, 15%, or 20% depending on your taxable income
- Additional: A 3.8% Net Investment Income Tax may apply to high earners (income over $200k single / $250k married)
Source: IRS Publication 550
Calculating Capital Gains
To calculate your capital gain, use this simple formula:
Capital Gain = Selling Price - Basis
Your "basis" is essentially what you paid for the property plus certain costs. It includes:
- The original purchase price
- Closing costs from the purchase
- Costs of improvements (like adding a room or renovating the kitchen)
For rental properties, you also need to account for depreciation recapture. This means you may owe tax on the depreciation deductions you've taken over the years, even if you have a loss on the sale.
Primary Residence Exclusion (Section 121)
One of the biggest tax breaks for homeowners is the primary residence exclusion. If you sell your home that you've lived in as your main residence, you may be able to exclude up to $250,000 of capital gains ($500,000 if married filing jointly) from your taxable income.
Requirements to Qualify
- You must have owned the home for at least 2 of the past 5 years
- You must have lived in the home as your primary residence for at least 2 of the past 5 years
- Use this exclusion once every 2 years
Source: IRS Topic No. 701 Sale of Your Home
Deferring Capital Gains with 1031 Exchange
For investment properties, you can defer capital gains tax indefinitely using a 1031 Exchange. This allows you to sell one investment property and reinvest the proceeds into another "like-kind" property without paying tax on the gain.
To learn more about this strategy, see our article on 1031 Exchange.
Calculating Your Tax Liability
Estimating your capital gains tax can be complex, especially with depreciation, improvements, and various exemptions. Save time and avoid mistakes by using a trusted calculator:
AllMoneyCalc - Capital Gains Tax Calculator