Advertisement

Can I Lower My Roth IRA & Estate Taxes?

Eric Reed
·8 min read

Home prices have nearly doubled in the last 10 years - and that could mean you owe some serious taxes if you are selling your home. After bottoming out around $259,000 in 2011, the average sale price of a house has marched steadily upward to more than $453,000 at time of writing. Like many trends, the pandemic may have accelerated this but housing prices had already been rising for years. This has come as great news for homeowners looking to sell. They stand to make some real money.

Unfortunately, with real money comes real taxes. If you sell real estate for a profit you will owe capital gains taxes on the money. Unfortunately, unlike the taxes held from wages, the IRS doesn’t take that money up front. You’ll have to calculate it and cut a check. There are ways to make that hurt less though. If you want help minimizing your tax bill from a home sale, consider working with a financial advisor.

Don't miss out on news that could impact your finances. Get news and tips to make smarter financial decisions with SmartAsset's semi-weekly email. It's 100% free and you can unsubscribe at any time. Sign up today.

What Are Capital Gains Taxes on Real Estate?

The capital gains tax is levied on any profits you make from selling an investment. This applies to most money that you make through buying and selling assets such as stocks, bonds and even real estate (such as your house). In the case of real estate, you would calculate your taxable profits as:

ADVERTISEMENT

Price you sold the property for – Price you paid to buy the property = Taxable profits

So, for example, say you bought your home for $260,000 ten years ago. You sell it today for $450,000. You would owe capital gains taxes on $190,000 (the difference between your purchase price and your sale price).

Long-term capital gains -- that is, gains on assets held for a at least a year - are generally taxed at a much lower rate than earned income (money that you get from working). In 2021, for single/married filers the capital gains tax rates have been set at:

  • 0 Percent - $0-$40,400 Single/$0-$80,800 Married

  • 15 Percent - $40,401-$445,850 Single/$80,801-$501,600 Married

  • 20 percent - $445,851+ Single/$501,601 Married

As of 2022, the ranges are as follows:

  • 0 Percent - $0-$41,675 Single/$0-$83,350 Married

  • 15 Percent - $41,676-$459,750 Single/$83,351-$517,200 Married

  • 20 percent - $459,751+ Single/$517,201 Married

So, from our example above, say that you sold your house and make a $190,000 profit in 2021. Assuming that you’re single you would calculate capital gains taxes on this sale as follows:

  • $40,400 * 0 Percent = $0

  • ($190,000 - $40,401) = $149,599

  • $149,599 * 15 Percent = $22,439

  • $0 + $22,429 = $22,429

This is a simplified version of finding your capital gains tax burden, but the basics are there. You could owe $22,429 in taxes on this sale. This is a lot, even when you remember that you made $190,000 in profit with which to pay it. (It’s even more when you remember that, having sold your home, you’ll need to find a new one in a white hot market…) Fortunately, the IRS has carved out an exception to help homeowners with that problem.

Mortgage rates are more volatile than they have been in a long time. Check out SmartAsset’s mortgage rates table to get a better idea of what the market looks like right now.

The Capital Gains Exclusion

If you profit off the sale of your home, you can exclude the first $250,000 of that profit from taxes. For married couples filing jointly, that number increases to $500,000.

Critically, this exclusion applies to your gains, not the total sale. So from our example above, say you sold your home for $450,000 as a single person. Your profit from the sale came to $190,000. You could exclude that entire profit from your taxes and would owe nothing.

On the other hand, say you made a $280,000 profit off the sale. After the capital gains exclusion you would owe taxes on the remaining $30,000. (Which, since all of that would fall within the 0 percent capital gains tax bracket, again comes to $0 in taxes.)

To qualify for this exclusion you must meet the ownership and use test. This means that you must have owned the house and used it as your main residence for at least two years out of the five years prior to its sale. This does not have to be continuous. You can live in the house periodically, so long as it comes to at least two years aggregate. (See IRS Publication 523 for a complete description of the exclusion test requirements.) Members of the U.S. military, foreign service, Peace Corps and active intelligence can calculate their continuous use differently based on their deployment schedules.

Calculate Your Capital Gains Taxes Correctly

As we mentioned above, capital gains on the sale of a house are slightly more complicated than ordinary investment profits. In addition to the original purchase price of the home, you can also deduct some closing costs, sales costs and the property’s tax basis from your taxable capital gains.

Closing costs can include mortgage-related expenses (for example if you had prepaid interest when you bought the house) and tax-related expenses.

Sales costs generally apply to any money you spent selling the house. This includes broker’s fees, listing expenses, legal fees, advertising fees, money you spent making the house look more presentable for sale, and other related costs.

The house’s tax basis is the cost of any major improvements you made to the property over the years. This is essentially any amount of money you spent on the physical structure that added value to the home. It is reduced by any depreciation in that structure (for example, if you added a deck but then let that deck fall apart), although depreciation is an uncommon problem for actively inhabited houses.

So, for example, say that you are single and bought a house for $250,000. You sell it for $750,000. You have the following associated costs:

  • $40,000 in renovations to the kitchen and bathroom;

  • $35,000 in broker’s fees;

  • $2,500 spent on cleaning and staging for open houses;

  • $5,000 on lawyer’s fees and other associated closing costs.

You would calculate your taxable capital gains as:

  • $750,000 – ($250,000 + $40,000 + $35,000 + $2,500 + $5,000) = $417,500

  • $417,500 - $250,000 (the capital gains exclusion) = $167,500

You would owe taxes on $167,500.

Do Not Sell Quickly

If at all possible, do not sell your home in under a year. You must wait at least two years to sell your house in order to qualify for the capital gains exclusion. However, even if you don’t qualify for the exclusion you still can ordinarily pay the reduced tax rate levied on investment assets.

This reduced rate is what’s known as the long-term investment rate. It only applies to assets that you have held for more than a year. If you own your property for less than 12 months, you have to pay taxes on any profits at the ordinary income rate (that is, the rate at which the IRS taxes work and earned income). This is significantly higher than the capital gains tax rate.

The Bottom Line

The main way to reduce your capital gains taxes is by making sure you calculate in all of the reductions that the IRS allows to your overall profits. After that, the capital gains exclusion will eliminate much of the money that most homeowners will make off their sales.

Homebuying Tips

  • It’s great if you can make money off your home, but first and foremost this has to be a place to live. With SmartAsset’s Mortgage calculator you can figure out exactly what that new house will cost you, letting you make the right call for your budget and your future.

  • A financial advisor can help you with tax planning so you don't overpay. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Mortgage rates are more volatile than they have been in a long time. Check out SmartAsset’s mortgage rates table to get a better idea of what the market looks like right now.

Photo credit: ©iStock.com/AndreyPopov