Since taxes are paid on almost everything, people look for ways to avoid paying them. One of the taxes that can be avoided is the capital gains tax that is paid on capital assets such as houses, etc.
Once you sell your house whether it’s a primary residence or investment property, you have to pay the tax especially when there’s a gain from the sale.
However, the question is, How long do you have to live in a house to avoid capital gains tax?
According to the IRS rules, to meet the owner and residence requirements, you have to own and live in the house as a primary residence for two years in the last five years to the date you are selling the house to avoid paying capital gains tax.
Importance of Capital Gains Tax
Although many people are trying to avoid it, the capital gains tax has its importance. The first is that it stimulates economic growth. No matter what people feel, capital gains tax is one way to grow your economy.
Capital gains tax discourages investors from selling the houses. Fear of this tax will reduce the rate at which investors buy and sell. Unless they are selling the house to buy another one, they will pay the tax.
How Long Do You Have to Live in a House to Avoid Capital Gains Tax?
When you get a house, many times you have the mind of staying there for a number of years unless there’s a sudden reason to move, like an increase in the size of the family.
If you are selling your house and you want to avoid paying the capital gains tax, you need to have lived in the house for two years.
That sounds easy, right? But the two years are only valid during the last five years to the date of sale.
If in the past five years you only lived in the house for 18 months, then you can’t avoid the capital gains tax; you’ll have to pay. The two years must be complete.
Also, it’s important to note that a few ways to avoid paying capital gains tax for a primary residence are to meet the owner requirement and residence requirement.
You can only meet the owner’s requirement if you own the house. You can only sell a house you owned and you have to own the house for at least two years in five years roll to be able to avert paying capital gains tax.
However, the residence requirement is that you should have lived in the house for some years which is about 2 years in 5 years before you can sell it and be free from paying the tax.
Do I Have to Own my Home for 5 Years to Avoid Capital Gains Tax?
Unless you are investing in properties, you can’t plan to buy a house to sell it within two years unless certain circumstances come up.
If you want to sell your house, you have to look back five years from the date of sale. In those five years, you don’t have to live in the house for five years. You just have to live in it for two full years.
You can even rent out the house for the remaining years. While counting the years, days of short vacation isn’t included and the house should be your primary residence.
How to Avoid Capital Gains Tax When Selling a House?
To avoid capital gains tax, below are the requirements you should meet:
1. Passing the Owner’s Test
You must be the owner of the house before you can sell the house. You should have owned the house for the past five years to the date of sale.
2. You Must meet the Residence Requirement
Even if you own a house and you want to sell it, you will still pay the tax if you don’t meet the residence requirement. You should have resided in the house as your primary residence for two years in the past five years. If you don’t live up to the two years, you will have to pay the tax.
3. Capital Loss
Actually, no one wants to make a loss during sales. But if you didn’t make any profit from the sale of the house, you don’t have to pay capital gains tax. The tax is deducted from the gains made on the sale.
4. Adding Home Improvement Cost
Another way to avoid the capital gains tax is by deducting the money you used to improve the home. Let’s say you bought a house 12 years ago for $200,000. In the course of living in it, you made some permanent installations to improve the home. If the improvements cost you $150,000, and you sold the house for $400,000. Your cost would be $350,000; $50,000 would be the profit. So the tax would be deducted from the $50,000.
There is a restriction to these requirements. You can only sell one house in two years to be tax-free. You can’t sell two houses at the same time.
How Much Will I Have to Pay?
In the US, the amount you pay as capital gains tax is dependent on your marital status and annual income. Below is the list of the long-term capital gains tax rate.
Singles earning from $40,400 and below will have their profit tax-free. Singles who earn from $40,401 to $445,850 will pay 15% of the capital gains as the capital gains tax. Singles who earn above $445,850 will pay 20% of the profit as the tax.
Married couples that are filing jointly will have their profit tax-free if they earn from $80,800 below. Those that earn from $80,801 to $501,600 will pay 15% of the capital gains. Couples that earn more than $501,600 will pay 20% of the capital gains as tax. This rule also applies to a surviving spouse.
Married couples filing separately will have their profit tax-free if they earn $40,400 below. Those that earn from $40,401 to $250,800 individually will pay 15% of the capital gains. Those who earn above $250,800 will pay 20% of the capital gains.
How to Qualify for Capital Gains Tax Exemption?
Like I mentioned earlier, if you want to qualify for capital gains tax, you have to meet the following requirements:
- You must have lived in the house for two full years in the past five years to the date of the sale.
- You should own the house.
- If you are a property investor, sell the house through a 1301 exchange.
- You shouldn’t hold the money but you are to give it to a third party.
- If you are a member of the uniformed service, you can defer the 5-year rule if you were called to service for an indefinite period or a period of 90 days.
- Also if you are living 50 miles away from the house performing your duty at your duty post, you can be exempted from the 5-year rule.
How Much Can I Exempt from Capital Gains?
The profit you make from the sales of the house is your capital gains. If you bought your house for $150,000 and you sold it for $400,000, you have gotten a profit of $250,000. And according to the IRS rule, $250,000 is exempted from the gains if you meet to requirements to be exempted from the tax.
To avoid paying the capital gains tax, you can also deduct the cost of home improvements that you’ve done over the years. If you deduct the cost from the gains, the tax would be deducted from the gains. And if there’s no amount left then you are free from the tax.
To avoid breaking a rule, you have to know the rule. A tax advisor is important as he or she would help you out with the steps involved in the payment of the capital gains tax. There are exemptions and there are restrictions to the exemptions. If you qualify for the capital gains tax exemptions, you are free to sell your house.