Capital Gain and Taxation
Capital gains are profits from selling real estate. Learn how long-term and short-term gains are taxed and how exclusions or 1031 exchanges work.
Definition
Capital gain is the profit realized from selling a property or investment for more than its purchase price. For real estate, gains are calculated by subtracting the purchase price, plus capital improvements and certain expenses, from the sale price. The Internal Revenue Service classifies gains as short‑term (property held less than a year) or long‑term (held longer than a year); long‑term gains typically receive favorable tax rates. Homeowners may exclude up to $250,000 (or $500,000 for married couples) of capital gains on a primary residence if they meet ownership and occupancy requirements. Investors can defer taxes by reinvesting proceeds through a Section 1031 like‑kind exchange. Planning for capital gains helps maximize net proceeds and ensures compliance with tax laws.
Why It Matters
$250,000 of gain tax free if you are single, $500,000 if you file jointly: that is the Section 121 exclusion, and it requires owning and living in the home two of the last five years. Sell at month 22 instead of month 24 and the whole gain becomes taxable. Washington's own 7% capital gains tax exempts real estate, so the bill that matters here is federal.
Examples
A married couple bought at $410,000 in 2013 and sells at $960,000. The $550,000 gain exceeds the exclusion by $50,000, and that slice is taxed at 15% or 20% depending on income.
A homeowner takes a job in Denver 19 months after buying. Because the move is work related and beyond 50 miles, she qualifies for a partial exclusion of roughly 79% of the full amount.
An investor sells a rental at a $300,000 gain, identifies a replacement within 45 days and closes within 180 to defer the tax through a 1031 exchange. The depreciation he claimed is still recaptured when he eventually cashes out.
Tips
Keep receipts for every capital improvement for as long as you own the home. A new roof, a remodeled bath, a new furnace: each raises your basis and shrinks the taxable gain dollar for dollar.
Count the residency requirement in days before you list. It is 24 months of occupancy within the 60 months preceding the sale, and those months do not have to be consecutive.
If you converted a rental into your residence, run the numbers before assuming the full exclusion. Periods of non-qualified use limit how much gain is excludable, and depreciation recapture never is.
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