If You’re Selling a House This Year, These Are the 6 Tax Tips You Need to Know

Tax season is confusing enough with W2s, charitable contributions, and student loan deductions. Add in a real estate sale and it’s enough to send even the savviest TurboTax expert running. But in a year where the market has been hotter than ever, more and more people are selling their homes — and they’re not always buying a new one right behind it. So, as they check that box that says, “I sold a house,” how can they prepare for any (expensive) surprises that might head their way on April 15?

While no one knows Don’t hesitate to call in a professional.

First, a caveat: These expert tips are helpful and it’s a good idea to come to the table with ideas, but Kate Ziegler, a real estate investor and Realtor in Boston, advises would-be real estate investors to call on a tax professional early in the process. A certified public accountant, or a CPA, with real estate experience helped her structure existing properties in a more advantageous way. They also advised on future purchases and sales, and how those might impact her tax bill. 

“Take the time to find someone who understands both your local real estate market, and also your goals, whether you’re investing on a larger scale or minimizing capital gains on a well-timed sale of your primary residence,” Ziegler says.

Familiarize yourself with short term vs. long term capital gains.

Historically, people were told to buy a home only if they planned on living there for three to five years. The pandemic changed everything. People found themselves in need of more space, moving across the country, or selling to cash in on a hot market. They needed to sell — and they needed to sell now. How long they’d been there didn’t matter.  

Some of those sellers found themselves with a surprise tax bill. “In some markets, there are additional taxes levied for selling within the first year of ownership, where municipalities are trying to discourage “flipping” or revitalizing depreciated homes for short-term re-sale,” Ziegler says.

Michael Gross, a CPA and certified financial planner, explains further: “These short-term capital gains are taxed at ordinary income tax rates. The top ordinary income tax rate is 37 percent. If they hold the property more than a year then the gain would be taxed at long-term capital gain rates. The top long-term capital gain rate is 20 percent.” The profit on a house often isn’t small and that 17 percent difference can make a big impact during tax season.

Ken Grodner, an accountant-turned-Realtor with the Hospitality Network Group at Keller Williams, adds an additional point to playing the long-term game: “If you are able to sell a property in a low-income year (e.g. you or your spouse leave a job), you can reduce or eliminate your capital gains tax.”

Consider the impact of residential exemptions.

“The tax implications of primary and non-primary residences differ, so a buyer purchasing a new primary residence without selling their current home should consider the tax implications of changing their residence,” Ziegler says. You can only claim a primary residential exemption on one property, and as soon as you change your address, your tax status changes on that second property. Additionally, if that property is being converted into a long-term rental or short-term rental, that will also affect its tax burden — and that rate will affect any rental profit calculations.

On the flip side of the residential exemption, if a seller is offloading a rental property but they’ve owned and occupied it as a principal residence for two of the five years before the sale, then they can convert it to a primary residence prior to the sale. In that case, Gross says, “When you sell the property you can exclude $250,000 of gain if single, or $500,000 if married filing jointly.”

Make sure you understand depreciation.

Gross explains that depreciation is a commonly misunderstood concept in the real estate tax world. Depreciation covers the necessary improvements that one should make to their property to keep it in tip top shape to both rent and sell. But owners often incorrectly assume this is a permanent deduction. He says, “Although it is deductible during the time the property is rented, it reduces the tax basis of the property, which ultimately increases the gain when the property is sold.”

Sell on an installment sale basis.

With real estate markets staying red hot, some homeowners are selling at sky high prices and waiting out the rush in a rental. For those primary residence sellers, they could be hit with capital gains for the amount above $250,000 if single or $500,000 if married filing jointly. Luckily, there is a way around the tax bill. Gross advises those sellers look at selling on an installment sale basis. “This would allow you to receive payment over a period of years and only a portion of the gain would be recognized each year, which would ultimately keep you in a lower tax bracket and result in paying less tax overall,” he says.

Look into a 1031 exchange if you’re selling an investment property.

If you have an investment property on hand and it’s time to sell, it might be wise to turn the proceeds from the sale around in what’s called a 1031 exchange. “This is a mechanism to allow sellers to reinvest their sale proceeds into a ‘like-kind’ purchase within 180 days of the sale closing,” Ziegler explains. 

When the proceeds from the sale are invested into another similar property, the seller avoids paying a hefty capital gains tax. The downside? The purchase’s order of operations can veer off course with one improperly submitted document. Grodner adds, “While that may initially seem like a long time, we often see clients scrambling to close before the 180 day deadline.”

This brings it all back to tip number one: make sure you have a professional on your side.