Capital Gains on Short Term Sales

As a taxpayer in the U.S., you will be subject to one of two different capital gains tax rates – the one you pay after you sell an asset you’ve owned for more than two years and the higher rate you pay if you’ve owned an asset less than two years.

People typically associate capital gains with taxes owed on profits from investments, and many people don’t view their primary residence through an investment lens. Everyone needs a place to live, so why is the home you buy out of necessity being treated like an investment?

The government’s answer to this question is a bit convoluted. If you’re selling your primary residence after living in it for many years, you may be able to avoid paying some capital gains taxes ($250,000 of profit for single tax filers and $500,000 for married couples filing jointly). This is known as the Section 121 exclusion.

Unfortunately, this capital gains tax break is only available if you’ve owned your home and lived in it for 24 months out of the past five years. If you’re in a situation where you are compelled to sell out of necessity, and you don’t meet the eligibility requirement, your capital gains tax exclusion options are more limited.

Bottom Line on Short-Term Sales

The inescapable reality is there’s no dodging capital gains if you’ve owned and/or lived in a property for less than two years, but there is a significant difference between owning a property for less than a year and owning it for more than a year.

Homeowners who sell their home less than one year after the initial home purchase are taxed at their marginal income tax rate, which is between 10 percent and 35 percent, depending on their tax bracket.

If you sell after owning a home for more than one year but less than two, you’ll be taxed at the capital gains tax rate for your income bracket, which may be zero, 15 or 20 percent. This is why, if you must sell as soon as possible, it’s generally preferable to hold off on a home sale until you’ve owned the property for at least a full year.

Are There Exceptions to the Short-Term Capital Gains Rate?

The IRS does recognize that life's unforeseen challenges can force an early home sale. The IRS may allow you to claim a partial exclusion of capital gains tax if you meet a very specific set of circumstances. Some of their exclusion eligibility scenarios include:

• You must relocate for a new job. This is only an option if your new office or job site is 50 miles farther from your current home than your old work location. If you work from home, your new job must be at least 50 miles away from your home. This rule also applies if your spouse or the home’s co-owner is subject to the same circumstances.
• People diagnosed with a serious illness or injury may be eligible if they’re forced to move in order to receive care. The health-related move list specifically covers “diagnosis, cure, mitigation or treatment.” You are also eligible if a family member in your household needs to be closer to the relevant healthcare professionals.
• There’s also a nebulous unforeseeable events exception that includes situations like your home was condemned or a disaster struck your house, including acts of God, man-made disasters and terrorist attacks. There are also exceptions for death, divorce, birth of two or more children from the same pregnancy and changes in employment status. 

You won’t be entitled to the full capital gains exclusion, even if you meet any of the above eligibility scenarios. Instead, you’ll need to do the calculations to prorate your exclusion.

Determining capital gains exclusion is undeniably complicated, which is why it’s likely in your best interest to work with an experienced tax preparer or accountant before filing with the IRS. Although getting professional assistance doesn’t guarantee you won’t be audited, it at least decreases the risk and ensures you have the paperwork to justify your claimed capital gains exclusion should proof be needed.

Impact of Home Improvements on Capital Gains Taxes

The capital gains exclusion isn’t necessarily your only option for capital gains reduction. Certain home improvements may also have a positive impact on capital gains tax. Money spent on improvements can be added to your basis (what you paid for the house). This decreases the difference between your home purchase and sale price, ultimately reducing profit (taxable gain) in the eyes of the IRS.

Not all expenses qualify, so it’s important to keep meticulous records of any renovations and consult with a tax professional before altering your filing.

Maximizing Your Sale Price Can Make Capital Gains Feel Less Painful

You might not be able to entirely dodge capital gains taxes if you find yourself in a situation where you simply can’t afford to wait two years or more before selling. However, the pain can potentially be reduced by receiving purchase offers that are significantly higher than the average sale price for your area.

The 72SOLD system can help. Our real estate professionals have mastered the art of collecting exceptional purchase offers at blazing speeds. Find out how much you should expect from your home sale and learn how our real estate agents near you can help.