When you sell a property like a house, land, or commercial building at a profit, taxes apply to the capital gains. Understanding how capital gains tax works on real estate transactions allows homeowners and investors to calculate taxes owed and optimize after-tax profits. This guide covers the capital gains tax on real estate rates, exceptions, planning strategies, and other considerations when selling real estate in 2023.
Overview of Capital Gains Tax on Real Estate
In most cases, when you sell a real estate investment or second home, you must pay capital gains tax on the profit between the original purchase price and the sale price. These capital gains are taxed at either short-term or long-term rates depending on your holding period:
- Short-term – Owned for 1 year or less and taxed as ordinary income.
- Long-term – Owned for over 1 year and taxed at preferential long-term capital gains rates.
You must report real estate capital gains on your federal tax return in the year of sale and can owe substantial taxes. However, primary residences receive an exemption up to $250,000 for single filers or $500,000 for married filing jointly.
Federal Capital Gains Tax Rates for 2023
For 2023, federal capital gains tax on real estate rates remain unchanged and are as follows:
Short-Term Rates
- Your ordinary income tax bracket applies. For example, 22% for single filers with income between $41,675 and $89,075.
Long-Term Rates
- 0% for single filers with taxable income up to $44,625
- 15% for single filers with taxable income from $44,626 to $492,300
- 20% for single filers with taxable income over $492,301
Higher income earners may also face the 3.8% net investment income surtax on gains.
Your total cost basis, holding period, income, and filing status determine the capital gains rate on real estate sales.
How to Calculate Capital Gains Tax on Real Estate
Follow these steps when calculating capital gains tax on real estate capital gains:
- Determine your total cost basis – This includes the original purchase price plus improvements and other costs like closing fees. Keep documentation on all investments in the property.
- Calculate the sale price – This is the amount you sold the property for.
- Subtract cost basis from sale price – The difference is your total capital gain.
- Factor in depreciation recapture – If you deducted depreciation previously, recapture taxes apply on part of the gain.
- Consider exemptions – Exclude any gains within the primary residence exemption limits.
- Determine holding period – Classify the gain as short-term or long-term based on whether you owned for over one year.
- Apply the appropriate capital gains rate – Use your income, filing status and holding period to find the rate.
- Account for any state taxes – Most states impose capital gains taxes as well. Factor these in.
- Calculate total taxes owed – Multiply your net taxable capital gain by the applicable rate. This is the tax bill to prepare for at closing.
Tip: Work with a tax professional or use software to ensure you accurately account for all variables impacting your taxable real estate capital gains.
Tax Considerations When Selling Real Estate Investments
If you plan to sell real estate investments like rental properties or commercial buildings, consider these strategies to optimize after-tax proceeds:
- Time the sale to qualify for long-term capital gains rates
- Harvest capital losses to offset gains
- Use a 1031 exchange to defer taxes on “like-kind” property
- Expense all allowable operating expenses before sale
- Claim all eligible depreciation deductions
- Avoid state taxes by using an out-of-state exchange intermediary
- Structure the sale in the most tax-efficient manner
Work closely with your CPA or tax advisor when selling significant real estate investments to maximize after-tax returns.
Primary Residence Capital Gains Exclusion
Selling your primary residence or second home comes with a major tax advantage – the capital gains exclusion. Up to $250,000 of gains for single taxpayers or $500,000 for married couples filing jointly qualifies for this exclusion when you meet the following tests:
- Owned the home for at least 2 of the past 5 years
- Lived in the home as your primary residence for at least 2 of the past 5 years
You can use the exclusion multiple times in your lifetime, but not more frequently than once every 2 years. Divorced couples can each claim the full exclusion on the same home if they meet the ownership and use tests.
This substantial exemption on primary home sales removes tax burdens for most homeowners selling their principal residence. But tax planning remains useful for maximizing gains above the exclusion amount.
State Capital Gains Tax on Real Estate
In addition to federal capital gains taxes, most states impose their own capital gains tax:
- Over 30 states fully tax long-term capital gains
- 7 states exempt most long-term capital gains
- Remaining states use federal AGI to indirectly tax a portion of capital gains
State capital gains rates range from 2% to 13.3% of net capital gains. Some states allow local taxes on capital gains too.
Check your particular state’s current capital gains rules when calculating total taxes so you understand the complete burden.
Conclusion
Selling real estate can generate large capital gains that trigger significant tax bills – especially on investments and second homes. But tax planning strategies like harvesting losses, optimizing holding periods, and leveraging exclusions allow homeowners and real estate investors to maximize after-tax returns on their property sales. Consult with a trusted tax professional to ensure you efficiently account for all federal and state capital gains tax on real estate when selling real estate in 2023.
