When you sell a piece of real estate for a profit, the Internal Revenue Service levies capital gains on your profit rather than on your actual proceeds from the sale. The first part of figuring out your taxable profit is to find your adjusted basis by adding up your original purchase price, any non-loan-related closing costs you paid when you bought the property, and any improvements you made. Subtract the adjusted basis from your amount realized, which is your selling price reduced by any commissions or other costs of sale that you pay at closing, to find your taxable profit.
As of 2013, any capital gains on the sale of assets held for a year or less will be taxed at your regular income tax rate. For the sale of a property held for over one year, the capital gains tax rate is 15 percent for most taxpayers. Single taxpayers with taxable incomes over $400,000 and married couples with incomes over $450,000 will pay a 20 percent long-term capital gains rate. In addition, singles with incomes over $200,000 or married couples earning more than $250,000 will pay an additional 3.8 percent Medicare surtax on both short-term and long-term capital gains.
Primary Personal Residences
Your primary residence is the home that you consider your main home. When you sell your primary residence, the IRS excludes your first $250,000 of profit from tax if you are single. If you are married, you get to exclude $500,000 of profit. In others words, if you sell the house that you live in with your spouse for a $550,000 profit, you will only pay capital gains tax on $50,000 of it. For you to receive this exclusion, you must have lived in the home as your main house for at least two of the past five years.
If you are selling a second home -- such as a vacation home that you used as a personal residence but not as an investment -- you don't get to exclude any of your gains. All of your profit will be subject to capital gains tax. However, there is a way around this. If you move into your second house for at least two years after selling your first house, you'll be able to take the capital gain exclusion against the sale.
Homes With Home Offices
If you ever claimed a home office deduction against your home, you may have to pay a special 25 percent Section 1250 depreciation recapture tax when you sell. As a part of your home office deduction, you're allowed to depreciate your home office over a 39-year life. However, if you sell your house for more than your depreciated basis, which is your adjusted basis less all of the depreciation that you were legally able to claim, you will need to pay the recapture tax on the difference between your depreciated basis and your selling price, up to being taxed on the maximum amount of depreciation you could have claimed. You will have to pay this tax even if you didn't take the depreciation deduction to which you were entitled.
Profits on investment properties are subject to capital gains tax, to the Medicare surcharge, and to the Section 1250 depreciation recapture tax. If you have held the property for a long time and done multiple cash-out refinances, it's very possible that your total tax liability could be more than the proceeds you receive at the sale. With this in mind, if you intend to purchase more investment property with the sale proceeds, setting up a tax-deferred exchange could be a good option. An exchange lets you carry your money and your depreciated basis forward into a new property so that you don't have to pay any of those taxes at the sale.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.