Can I Avoid Capital Gains by Buying Another House?
Is it possible to avoid capital gains tax by buying another house? While the answer is not a straightforward “yes” or “no,” there are certainly ways to minimize your tax burden when selling a property. Let’s go over the basics of capital gains tax, how buying another house can help, and what you need to know before taking the plunge.
What Is a Capital Gains Tax?
Capital gains tax is a tax on the profit you make from selling an asset, such as a property or stocks. In the context of real estate, the capital gains tax applies to the difference between the purchase price of the property and the sale price. For example, if you bought a property for $300,000 and sold it for $500,000, your capital gain would be $200,000.
The amount of capital gains tax you’ll owe on the sale of a property depends on several factors, including your income, the length of time you owned the property, and any deductions you’re eligible for. In general, the tax rate for long-term capital gains (property held for more than a year) ranges from 0% to 20%, depending on your taxable income.
How Buying Another House Can Help Avoid Capital Gains Tax
One way to avoid or minimize capital gains tax when selling a property is to use the capital gains exclusion. This exclusion allows you to exclude up to $250,000 (or $500,000 if you’re married and filing jointly) of capital gains from the sale of your primary residence, as long as you meet certain requirements.
To qualify for the capital gains exclusion, you must have owned and used the property as your primary residence for at least two out of the five years leading up to the sale. Additionally, you cannot have used the exclusion for another property sale within the past two years.
So, how does buying another house come into play? If you’re planning to sell your current primary residence and buy another one, you can use the capital gains exclusion to exclude up to $250,000 (or $500,000 if you’re married and filing jointly) of capital gains from the sale. This means that you’ll owe less in capital gains tax, or potentially none at all, depending on the amount of your gain.
Requirements for Using the Capital Gains Exclusion
As mentioned earlier, there are specific requirements you must meet to use the capital gains exclusion. Here’s a quick overview:
- You must have owned and used the property as your primary residence for at least two out of the five years leading up to the sale.
- You cannot have used the exclusion for another property sale within the past two years.
- You must meet certain ownership and use tests if you’re a member of the military or if you’ve been displaced from your home due to a natural disaster or similar circumstance.
- You must report the sale of your primary residence on your tax return and file Form 1099-S if you received proceeds from the sale.
It’s important to note that the capital gains exclusion only applies to your primary residence. If you’re selling a rental property, vacation home, or other type of property, you’ll need to pay capital gains tax on the profit.
Other Ways to Defer or Avoid Capital Gains Tax
In addition to using the capital gains exclusion, there are other ways to defer or avoid capital gains tax when selling a property. Here are a few options:
- 1031 exchange: This allows you to defer paying capital gains tax by reinvesting the proceeds from the sale of one property into another like-kind property.
- Installment sale: This allows you to spread out the payment of capital gains tax over several years by accepting payments from the buyer over time.
- Charitable donation: If you donate your property to a qualified charity, you can avoid paying capital gains tax altogether.
These options can be complex, so it’s important to work with a qualified tax professional or financial advisor to determine which strategy is best for your situation.
Pitfalls to Avoid When Trying to Dodge Capital Gains Tax
While there are certainly ways to minimize your tax burden when selling a property, it’s important to avoid certain pitfalls that could land you in hot water with the IRS. Here are a few things to keep in mind:
- Don’t try to live in a property for a short time just to qualify for the capital gains exclusion. The IRS has strict rules around what constitutes a primary residence, and trying to skirt those rules could result in fines and penalties.
- Don’t try to claim the capital gains exclusion for a property that’s not your primary residence. If you’re caught, you could owe back taxes, penalties, and interest.
- Don’t try to hide assets or income to avoid paying capital gains tax. This is considered tax fraud and can result in serious legal consequences.
The Process of Buying Another House to Avoid Capital Gains Tax
If you’ve decided that buying another house is the best way to avoid or minimize capital gains tax, here’s a general overview of what you can expect:
Determine your budget
Before you start house hunting, it’s important to determine how much you can afford to spend on a new property. You’ll want to take into account your current income, expenses, and any financing options you’re considering.
Find a property
Once you have a budget in mind, you can start looking for a property that meets your needs and fits within your budget. You’ll want to work with a real estate agent who understands your goals and can help you find properties that meet your criteria.
Depending on your financial situation, you may need to secure financing to purchase your new property. This could involve getting pre-approved for a mortgage or exploring other financing options, such as a home equity loan or line of credit.
Sell your current property
Once you’ve found a new property and secured financing, you’ll need to sell your current property. You can use the capital gains exclusion to minimize your tax burden, as outlined earlier in this article.
Move into your new property
‘Once you’ve sold your current property, you can move into your new property and enjoy the benefits of homeownership once again.
We Buy Homes in St. Louis, Missouri
If you need to sell your house fast but don’t want the hassle of a traditional home sale, contact Klamen Real Estate Buyers. We buy houses as-is. No repairs are needed. Avoid closing costs and realtor commissions. Close in as little as seven days. Call 314-721-6800 to get a fast cash offer from our local home buyers in Missouri.