Sure, property taxes aren’t fun while you own a home or investment property. But what about taxes on real estate sales? Do you pay taxes when you sell a house? Are taxes on real estate sales different for homes versus investment properties?
Selling properties isn’t cheap. Beyond the cost of hiring a real estate agent, closing costs, and potential repairs, beware of capital gains tax and other possible taxes. It can take a serious chunk out of your profits, so make sure you run the numbers before selling.
Do You Pay Taxes When You Sell a House?
It depends on several factors. You technically owe capital gains tax on all profits, but the IRS does offer an exclusion for homeowners, up to a certain amount (more on that shortly).
Whether you owe long-term or short-term capital gains tax depends on how long you owned the property. And whether you owe Net Investment Income Tax (NIIT) depends on your taxable income and the type of real estate investment.
That’s a lot of “it depends.” Let’s start from the beginning.
What Is Capital Gains Tax?
In simplest terms, the government charges capital gains tax when you earn a profit from the sale of any asset. Put another way, the sales price minus your cost basis (the original purchase price and your expenses and capital improvements). Many people think of capital gains tax as due from selling investments like stocks or bonds, but it also applies to real estate assets.
The IRS breaks down capital gains as either short-term or long-term. Captain Obvious: that’s based on how long you owned the property or portion of the property.
- Short-term capital gains tax: For investors who have owned an asset for less than a year and then sell, they’ll be stuck paying short-term capital gains tax which is equal to your ordinary income tax rate, which can go all the way up to 37%.
- Long-term capital gains tax: Investors who sell their share after owning an asset for more than a year pay long-term capital gains tax. You’ll pay 0%-20% on the profit you make in the sale, depending on your income (more on that in a minute).
So, you pay lower taxes by buying and holding properties for at least one year.
Selling Your Primary Residence
Selling your home is a whirlwind of a process, followed by a parade of fees and closing costs. Then Uncle Sam hits you with one more as the cherry on top: capital gains tax.
Thankfully, most homeowners — with the exception of the ultra-wealthy — qualify for the homeowner exclusion up to a certain amount of profits. The Section 121 exclusion allows homeowners to exclude up to $250,000 of the gains if you file as an individual on your taxes, or up to $500,000 for married couples who file jointly.
You do have to meet the requirements to take the homeowner exclusion on a principal residence however. You must have owned and lived in the home for at least two of the last five years to qualify for it. Note that you’re likely not eligible for the exclusion if you’ve already excluded the gain from a different sale of a home during the two years prior to the sale of your current home.
If you house hack multifamily properties, consider moving in for two years, then moving out and holding the property as a rental for up to three more years before selling. By doing so you can avoid capital gains taxes up to $250,000 or $500,000.
What the #%& are real estate syndications, and do they really earn 15-30% returns?
Selling Investment Properties
With no homeowner exclusion, capital gains taxes put a deeper dent in returns on investment properties.
If you’ve owned the property for less than a year, you pay short-term gain taxes at your ordinary income tax rate.
For those who have owned their property for more than a year, long-term capital gains tax apply. Most property owners pay 0-15% on the gain they made in the sale of one of their properties. Here’s a quick breakdown of long-term capital gains tax brackets for 2023:
|Capital Gains Tax Rate||Single||Married Filing Jointly||Head of Household|
|0%||$0 – $44,625||$0 – $89,250||$0 – $59,750|
|15%||$44,626 – $492,300||$89,251 – $553,850||$59,751 – $523,050|
|20%||$492,301 and up||$553,851 and up||$523,051 and up|
|Additional Net Investment Income Tax (NIIT)|
|3.8%||MAGI above $200,000||MAGI above $250,000||MAGI above $200,000|
Now, you’ll only pay capital gains tax on the difference between what you bought the property for originally and the gain you made when you sold it, minus expenses and capital improvements.
To give you an example, Joe is a long-time landlord ready to retire and sell his investment property. Joe bought the property for $300,000 and is selling now for $450,000. So, Joe has a capital gain of $150,000. Impressive, Joe!
Joe is single and earned $50,000 in regular W2 income from his full-time job, so for capital gains purposes, the IRS looks at his total combined income of $50,000 regular income plus $150,000 in capital gains: $200,000. That means his capital gains are taxed at the 15% rate, so Joe pays $22,500 in long-term capital gains tax on his profit.
Note that unlike regular income taxes, the IRS taxes all of your capital gains at the tax rate determined by your total combined income. In contrast, regular income gets taxed in tiers: your first $11,000 is taxed at 10%, the next $34,725 taxed at 12%, and so on (using 2023 as an example year).
Finally, long-term capital gains don’t affect your regular income or push you into a higher tax bracket. It’s taxed separately, on its own bracket schedule (listed above).
Taxes on Flipping Investment Properties
Investors who flip houses and hold them shorter than 12 months must pay short-term capital gains rather than long-term. This means they pay taxes at their standard income tax rate on the houses they flip.
For example, imagine Joe had flipped the house mentioned above. That $150,000 profit would tack onto his regular income, taxed up to 37%. Yikes.
If you qualify as a real estate broker-dealer, or someone in the business of buying and selling real estate, expect higher taxes. Beyond paying taxes on real estate sales at your regular income tax rate, you’ll also owe self-employment taxes: double FICA taxes totaling 15.3%.
Real estate wholesalers should expect similar treatment by the IRS.
Real Estate Crowdfunding Tax Benefits
Crowdfunding real estate involves putting up small amounts of money with other investors so you can purchase a rental property (or properties). You’ll all run your money through a company like Groundfloor and Fundrise who manages the actual investments.
Crowdfunding has become popular because of how easy it is to get started. Younger investors flock to it, with minimum buy-ins often at just a few dollars. But like all investments, real estate crowdfunding comes with tax consequences.
When you invest through crowdfunding platforms, you pay taxes on your returns. The taxes you pay depend on the investment. For example, interest payments and ordinary dividends are taxed at regular income tax rates. The IRS taxes “qualified dividends” at the lower long-term capital gains tax rate however.
Speaking of capital gains, some real estate crowdfunding platforms offer fractional ownership in properties. When those properties sell, you and the other investors earn a capital gain. Most real estate crowdfunding capital gains are long-term, but it’s possible a crowdfunding platform could return you short-term profits.
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Real Estate Syndication Tax Benefits
Real estate syndications are similar in many ways to crowdfunding, but often take place privately rather than publicly advertised through crowdfunding platforms. Some only allow accredited investors, where the real estate syndicator or “sponsor” raises money from a handful of wealthy investors. But others allow middle-class investors, which is what we focus on in our Co-Investing Club.
You receive a Form K-1 each year from the sponsor, listing your taxable profit or gain. In the first few years, you typically show a loss on paper, even while you earned distributions, because of depreciation. Many sponsors do a cost segregation study upon buying the property, to take even more depreciation in the early years. It’s one of the main real estate syndication tax benefits. You can use that paper loss to offset other streams of passive income, or carry it forward to offset capital gains upon the property’s sale.
Sales of syndication properties or portions of properties are taxed in the same way as other investment properties, via capital gains tax. Syndication deals require that investors remain invested for the life of the investment, often three-to-seven years. So, profits on sales are typically taxed at the long-term capital gains rate.
Check out our free class on syndication investing for more real estate syndication tax benefits.
Net Investment Income Tax (NIIT)
Higher earners must also pay NIIT on their net investment income. If you earn more than $200,000 as a single person, or more than $250,000 as a married couple filing jointly, you’ll owe an extra 3.8% tax on any net investment income that exceeds those thresholds.
For example, you’re single and you earned $200,000 in active income (your modified adjusted gross income or MAGI) last year and sold a rental property for a capital gain of $50,000. You owe an extra 3.8% NIIT tax on that $50,000 capital gain, for an extra $1,900 in taxes.
If your investment income pushes you over the threshold, you only owe NIIT on the overage. Modifying the previous example, say you earned a MAGI of $180,000 last year, plus that $50,000 capital gain. You owe the extra 3.8% NIIT on $30,000 rather than the full $50,000, since you were only over the $200,000 threshold by $30,000.
For the purposes of NIIT, the following investment income counts:
- Capital gains (short- and long-term)
- Dividends (qualified and nonqualified)
- Taxable interest
- Rental and royalty income
- Passive income from investments you don’t actively participate in
- Taxable portion of nonqualified annuity payments
There are a lot of perks to owning real property, whether your personal residence or investment properties. You collect cash flow for years as an active or passive investor, and upon selling, score lower tax rates on your investment gains.
Usually taxed at 0-15% of the profit on a property, investors can avoid the highest income tax rates. Most homeowners avoid capital gains tax entirely when it comes time to sell.
Consider it one more perk of real estate investing.♦
How have you minimized taxes on real estate sales?
Better to be tax educated than to pay tax blindly. There are many tax benefits that we opt to miss out.
2022 has been a roller coaster ride. Here’s to a mellower 2023 for both stocks and real estate.
Yeah it’s been a very volatile year. Excited to see what comes next!
Hoping my properties appreciate enough that I actually have to worry about taxes 😉
Haha, I hear you Samantha!
Very timely post. Thanks for sharing
Glad it was helpful Cesar!
Always need to keep one on the tax bill, to make sure the juice is worth the squeeze
So true Kevin!
My questions about real estate tax had been answered. Good read!