If you’re preparing to sell your home in Western North Carolina, you may be wondering whether you’ll be subject to capital gains taxes on the sale of your property. You might be thinking, “What exactly does this tax apply to, and how do I avoid paying capital gains taxes?” We’re here to help. Keep reading to learn more about the federal capital gains tax on real estate, what taxes you can expect from the state of North Carolina, and ways you can reduce the amount of capital gains taxes you’ll pay. With any tax discussion, it’s imperative to discuss your situation with your CPA.
What is capital gains real estate tax?
Capital gains taxes are charged when one sells an investment, such as stock shares, jewelry, coins, real estate, or another capital asset for a profit, meaning the asset must have increased in value throughout the holding period. Investments that were owned for more than a year and then sold for a profit are known as long-term capital gains, per Investopedia. Long-term capital gains are subject to federal capital gains taxes, in addition to taxes levied by the state in which the home is located. Assets held for less than a year and then sold are considered to be short-term capital gains, and they are taxed at the seller’s income tax rate.
Importance of Capital Gains Tax
It’s crucial to be aware of capital gains tax when selling a home, especially if that home was a secondary residence or vacation home. You’ll want to be fully aware of the taxes you’ll owe so you can plan accordingly.
How is capital gains calculated on sale of property?
Tax rates on net capital gain are subject to change and the amount you’ll pay is determined by your tax bracket. According to the Internal Revenue Service, if you make under a certain amount of taxable income, you may not be subject to capital gains taxes on the sale of your property; refer to the IRS website to see current income thresholds and find out what rate you qualify for.
Capital Gains Tax in North Carolina
In addition to federal capital gains taxes, North Carolina taxes capital gains at the income tax rate. The current North Carolina income tax rate is available on the NC Department of Revenue website.
Capital Gains Tax When Selling a Primary Residence
Tax laws regarding capital gains vary for different kinds of home sellers.
Those selling second homes, rental properties, or flipped houses are typically subject to capital gains taxes, while the IRS offers certain exceptions for homeowners selling their primary residence.
How do I avoid capital gains tax when selling a house?
If you’re selling your primary residence, the IRS allows you to exclude some of the profit from being taxed. Known formally as the Section 121 exclusion, this rule states that you can exclude $250,000 of capital gains if you’re single and $500,000 of capital gains if married and filing jointly. Check the IRS page on this topic to see whether you qualify, as there are some scenarios where you can’t claim the Section 121 exception.
What is the 2 out of 5 year rule?
This rule refers to the fact that you must have lived in the home for at least two of the five years before you sold it (or 24 months, even if they weren’t consecutive – short vacations don’t count against you).
One more thing to keep in mind: If you renovated your home before selling it, you can add the cost of those improvements to your home’s cost basis, which is the total amount you paid for it, plus costs, fees and capital improvements. Cost basis comes into play when calculating capital gains, so factoring in your renovation costs can potentially reduce the amount of taxes you owe. According to Capital One, capital gains are calculated by subtracting the adjusted cost basis (which contains capital improvements) from the home’s sale price. When the cost basis goes up, the amount of capital gains tax you owe might go down (or might be nonexistent, thanks to the Section 121 exclusion mentioned above).
Capital Gains Tax When Flipping Houses
If you’re planning to sell a house that you bought and restored in order to make a profit, keep in mind that, if you owned the property for less than one year, you’ll be making short-term capital gains on the sale. This means you’ll be taxed at your income tax rate on the profit you make – not your capital gains tax rate. For many people, this ends up being more costly than it would be if they had held onto the property until after the one-year mark.
How to Defer Capital Gains Tax on Flipping Houses
You may be able to avoid capital gains tax on a flipped house by taking advantage of IRS Code Section 1031. In this scenario, you would sell your investment property and buy another “like-kind” property right after, essentially deferring the taxes as you “trade” one property for another. This rule doesn’t apply if you’re selling a primary residence and buying a rental property or house to flip, hence the “like-kind” specification that requires both properties to be used for a similar purpose. For more details on the Section 1031 exchange, consult the IRS’ full publication on sales and other disposition of assets.
Tax Planning Strategies in North Carolina
As you prepare to sell your house in North Carolina, it’s important to be aware of the taxes you’ll owe after the sale. Take time to estimate whether you’ll make capital gains on the sale, and if so, whether you’ll owe capital gains taxes to the IRS. Consider all the exemptions listed above if you’re selling your primary residence; because the threshold is high, most sellers won’t have to pay capital gains taxes at all. However, don’t forget to factor in any taxes you’ll owe to the state of North Carolina on the capital gains. Remember that NC taxes capital gains as income.
Conclusion and Expert Insights
When you get ready to sell, it’s important to plan ahead if you anticipate owing capital gains taxes. Fortunately, you’re not alone! If you have questions or concerns about whether or not you’ll be faced with these taxes, reach out to our team here at Freestone Properties. Of course, it’s imperative to discuss your unique situation with your CPA, financial advisor, or tax professional.
Our listing agents have years of experience selling properties in Asheville, NC and the surrounding area, with special emphasis on vacation, rental, and investment homes.
