Understanding potential capital gains tax on real estate in a hot market

An interview with wealth planner Isabel Barrow, director, financial planning at Edelman Financial Engines

Article published: April 13, 2024

If you sold a home last year, you may be wondering how it will impact the amount of taxes you will owe this year. Barrow offers some valuable insights to help you be aware of potential tax implications* so you can plan for what’s to come.


Q: How does a home sale impact the amount of taxes you will owe? 

A: If you were fortunate enough to make a large profit on the deal, be aware that you may have an unexpected tax bill on this capital gain. How much you may owe depends on a few key factors:

  • Was it a primary residence, a secondary residence or a rental property?
  • Are you single, married, divorced or widowed?
  • How long did you hold the property?
  • What state do you live in?

Capital gains exclusion for sale of primary residence

If the home was a primary residence, the result is less complicated since many people may enjoy a sizeable exemption on their gain – up to $250,000 for single filers and $500,000 for married couples filing jointly. However, if you earned more than the permitted exemption, you may want to talk to your tax advisor or financial planner. You can discuss with them whether you’re able to adjust your cost basis – the price you bought the home for – to account for any improvements made to the home, or if you qualify for the exemption at all.

Historically, the sale of a primary residence wouldn’t trigger an unexpected tax bill for most people. However, with the continued surge in real estate prices, and with more retirees downsizing out of homes that have seen steady appreciation for years, there are more situations where this capital gains tax might crop up.

Short-term capital gains tax

If you’ve held the property for exactly one year or less, short-term capital gains rates would typically apply. These are generally the same as ordinary income tax rates, which are higher than long-term capital gains rates. Take note: You usually won’t qualify for the primary residence exemption if you’ve lived in the home for less than two of the previous five years, or if you’ve used this exemption for another home sale within the previous two years.

In many states, if you’re subject to federal capital gains on the sale, there may be a chance you’ll also be subject to state capital gains tax. Make sure to check what the state tax rules are where you live.


Q: Does the length of time you owned the home impact your tax bill for the sale? 

A: Yes. Even if it’s a primary residence, if you’ve held the property for less than a year, the capital gains may be taxed at short-term capital gains rates (higher than long-term capital gains rates). And again, you generally won’t qualify for the $250,000/$500,000 exemption if you’ve lived in the home for less than two of the previous five years.

If you’ve owned the home for many years and are selling at a significant profit, you may end up owing on any gain that exceeds the primary residence exemption. With soaring property values, some sellers – especially longtime homeowners – may be over this threshold and subject to a capital gains tax.

Typically, the costs, fees and potential taxes on selling a home within the same year or two you purchased it could negate any profit you realized in the property value. Bottom line – it’s usually not a great financial plan to flip a home unless it’s your full-time business! Before you make a move with one of your largest assets, it’s a good idea to get advice from your financial planner on how this impacts your wallet.


Q: How can you figure out at what capital gains rate you’ll be taxed for selling your home? 

A: The capital gains rate that may apply when selling your home depends on a few things, such as:

Your capital gains rate is based on your income – and this includes the gains you just realized from the sale. You may be able to offset some of these gains with losses, regardless of the type of investment generating the loss. This means you can take stock market losses to offset your real estate gains. Depending on your taxable income and filing status, long-term capital gains tax rates are either 0%, 15% or 20% for most assets held more than a year. Keep in mind, you may also be subject to a 3.8% net investment income tax, which means the top federal capital gains rate could come to 23.8%.

Don’t forget that your state may also apply a capital gains tax (and most do), so you will have to pay that as well.

Adjusted cost basis of home sold

Your cost basis plays a role in capital gains exposure as well. That’s why it’s important to keep a record of all your home improvement expenses. These costs may help you increase your cost basis and, ultimately, reduce your gain. After factoring in the money spent on home improvements, this could take you back within the $250,000/$500,000 exemption.


Q: Are there any other factors that can impact your tax bill after you sell a home? 

A: Other factors that might impact your tax bill are expenses related to improving the property. If a project was considered an improvement, it may be something you can add back to your cost basis. However, if you own the property as a rental, the taxation is very different. While you don’t benefit from the primary residence exemption, you do get a tax break during the years you owned it as a rental, by depreciating the property. In the future, you’ll have to consider depreciation recapture on a rental property and typically pay tax on that in addition to your capital gains.

Confused yet? This is exactly why it’s important to run these scenarios by your financial planner and tax advisor before you make a decision that could have long-term implications.


Q: What can you do to lower your tax bill if you sold your home last year? 

A: Be sure to gather all documented records of home improvement expenses. You may also be able to deduct certain fees or expenses related to the sale. These typically include expenses like advertising the property, appraisal fees, attorney fees, closing costs and a few others. Talk to your tax preparer to determine what qualifies for deduction.


Q: If you’re planning to sell your home in the future, how can you better prepare for the potential tax consequences?

A: To prepare for a home sale, no matter how far in the future it may be, it’s important to retain your records. Save everything related to improvements on your home. Create a file with your receipts and expenses, and save them – these may be important even 20 years from now! While you can’t take a deduction for these expenses on a primary residence, when it comes time to sell, you may need them to show that your cost basis is much higher. Also, if you get divorced or your spouse passes away, you have a limited period to sell the property and still get the larger $500,000 capital gains exemption for joint filers before the $250,000 single filer status applies.

Planning ahead and being aware of the potential tax implications of a home sale can go a long way toward minimizing the financial impact. To learn more about how to prepare for managing your taxes after the sale of a home, contact us today to connect with one of our financial planners.



Isabel Barrow is a Chartered Retirement Planning CounselorSM with deep knowledge of federal and military retirement benefits as well as the high-net-worth space. 



Neither Edelman Financial Engines nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to include your qualified tax and/or legal professionals in these discussions and decisions to help determine the best options for your particular circumstances.

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