Could you face a tax bill on your home sale?

The rapid rise in home prices could lead to some tax surprises.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print

Key takeaways

  • With the rapid rise in home prices, more and more owners may find their home appreciation has exceeded the limits of the primary residence tax exclusion.
  • The cost of any remodels and improvements while you own your home can increase your cost basis and help reduce a potential tax bill.
  • Be sure to consult with a tax professional to better understand your personal situation.

It's no secret that US home prices have been on a tear in many areas for the past 2 years. The imbalance between supply and demand—with a steady rush of buyers competing over unusually low inventory—has created a challenging market for buyers, but a rewarding dynamic for sellers.

Get more Viewpoints. Sign up for the Fidelity Viewpoints® weekly email for our latest insights. Subscribe now.

All that rapid appreciation has been a boon for owners' net worths. But it also means that more and more owners may need to anticipate a capital gains tax bill when they eventually sell.

"Growth in the value of your property means you'll make more if you sell it—and that means you might owe more," says Meredith Stoddard, Fidelity life events experience lead.

Understanding the capital gains exclusion

Some people may be surprised to learn that it's even possible to owe capital gains tax on their home. That's because there's an exclusion on gains from the sale of a primary residence, which generally lets sellers exclude up to $250,000 in gains from their income (or $500,000 for certain married taxpayers filing a joint return and certain surviving spouses).1

While those amounts have been generous enough in the past that even long-time homeowners could potentially sell without a tax consequence, the recent dramatic run-up in prices may have more sellers bumping up against the exclusion limits. (The current exclusion amounts have been in place for more than 20 years, and were adopted in the Taxpayer Relief Act of 1997.2)

The exclusion is intended to apply to the home you live in, not investment properties, so to qualify for it you must meet the IRS's ownership and use tests. The exclusion rule generally allows a taxpayer to exclude from gross income gain realized from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, the property has been owned and used by the taxpayer as the taxpayer's principal residence for a period totaling 2 or more years. The exclusion is allowed each time a taxpayer meets the eligibility requirements, but generally no more often than once every 2 years.3

Understanding potential tax consequences

If you do have to pay capital gains tax, how much you owe will depend on how long you owned the house, your filing status, and your income.

Selling a house you've owned for 1 year or less generates the steepest potential tax rate. In that case you don't qualify for the exclusion and gains are considered short term, meaning they'll be taxed at ordinary income rates, which can run as high as 37%. If you've owned the home for more than 1 year but less than 2, then you still don't qualify for the exclusion, but you'll pay lower, long-term capital gains rates on gains.

Potential tax exposure at a glance
If you've owned your home…

1 year or less

  • You don't qualify for the exclusion
  • Your net gain is generally taxable at ordinary income rates

More than 1 but less than 2

  • You don't qualify for the exclusion
  • Your net gain is generally taxable at more favorable long-term capital gain rates

At least 2 years

  • You may qualify for the exclusion
  • Your net gain above the exclusion is taxable as a long-term capital gain

(Learn more about ordinary income tax rates and strategies for managing capital gains tax exposure.)

Adjustments that can impact your tax bill

Calculating your gain is more complicated than simply taking the sale price and subtracting your original purchase price. Instead of selling price, taxes will be based on the "amount realized" on the sale, which accounts for many selling expenses.4 And instead of original purchase price, sellers subtract their "adjusted basis," which factors in the purchase price, but also certain purchase expenses and the cost of any improvements made to the home over the years.4

Altogether, this means there are potentially 3 stages along the way of the homeownership journey when it makes sense to keep track of relevant expenses.

Even if you have no plans to sell anytime soon, try to keep track of money you put into your home, particularly if you're going through any major remodeling or renovations. "Renovation expenses can add up," says Sarah Shannonhouse, manager for tax practice and ethics with the American Institute of CPAs. "They can increase the cost basis of the home, lowering your profit at the time of sale and ultimately, the tax bill."

To ensure you have the proof you need to get this adjustment, make sure to keep detailed records of the dates and descriptions of any improvements, as well as the companies that performed the work and your paid invoices. "It can be helpful to keep copies of permits, blueprints, and photos, even though they're not required," adds Stoddard. "The important thing is to keep your records organized, so another person could make sense of them if you ever need to provide proof of your improvements."

Be aware that gain from the sale or exchange of a principal residence allocated to periods of nonqualified use is not excluded from gross income.5 The portion of gain from the sale of property attributable to depreciation after May 6, 1997, is not eligible for the exclusion.6 

A tax professional can help you better understand your personal situation—not only in terms of working out your adjusted cost basis, but also in understanding the impact of any gains on your adjusted gross income and modified adjusted gross income (which can affect other aspects of your finances).

Offsetting capital gains with losses

Homeowners may also be surprised to learn that they can potentially offset capital gains on their home with realized capital losses on securities or other assets. This may be possible if you sell other assets at a loss in the same year you sell your home, or if you have losses from previous years that you've carried forward for tax purposes. If you're considering pursuing tax-loss harvesting by selling securities, just be mindful of any potential for wash sales and not to throw off your investment plan. Consider working with a financial professional to identify a tax-loss harvesting strategy that's consistent with your long-term investment goals.

With home values moving fast, capital gains on home sales may become part of the new normal for many homeowners. That's not all bad, though. Says Stoddard, "The silver lining of owing capital gains taxes is that it means you have gains on your investment—and that's a good thing."

Next steps to consider

Visit Life Events

Tools, resources & tips to help you navigate life's big moments.

Should you rent or buy?

Run the numbers with our handy calculator.

Buying or selling a house

Get tips and tools to help you through the journey.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be " "

Your e-mail has been sent.

Your e-mail has been sent.

Sign up for Fidelity Viewpoints®

Get a weekly email of our pros' current thinking about financial markets, investing strategies, and personal finance.