What Taxes Do You Owe When Selling Your Home?
Selling your home can be a major financial milestone, but it also comes with important tax considerations. Whether you’re selling your own residence or dealing with an inherited property, understanding how capital gains tax works, and how the step-up in basis can save your heirs money, is iimportant for smart financial planning.
Taxes When You Sell Your Primary Residence
When you sell your primary home, the IRS may tax you on the profit, known as a capital gain. However, most homeowners benefit from a generous exclusion. If you’re single, you can exclude up to $250,000 of profit from capital gains tax. If you’re married and file jointly, that exclusion doubles to $500,000. To qualify, you must have owned and lived in the home for at least two out of the last five years before the sale.
For example, if you bought your house for $300,000 and sold it for $600,000 as a single filer, you’d only owe capital gains tax on $50,000 ($600,000 sale price minus $300,000 purchase price minus $250,000 exclusion). If you’re married and filing jointly, you wouldn’t owe any capital gains tax on that sale since your $500,000 exclusion covers the full gain.
If your profit exceeds the exclusion, the excess is taxed at long-term capital gains rates, typically 0%, 15%, or 20%, depending on your income and filing status. Short-term gains (if you owned the home for a year or less) are taxed at ordinary income rates.
It’s important to keep records of your purchase price, any major improvements (which increase your cost basis), and selling expenses to accurately calculate your gain and minimize your tax bill.
Purchase price = $500,000
Kitchen renovation = $30,000
Home sale price = $1,030,000
Taxes owed = $0 ($1,030,000 sale price - $530,000 purchase price)
The capital gain, in this case, is $500,000 (remember, the first $500,000 gain is excluded for married couples who have lived in their house and owned it for 2 out of the previous 5 years).
If the kitchen renovation was not completed, the capital gain would be $30,000 ($1,030,000 - $500,000).
What Happens If You Inherit a House?
If you inherit a home from a parent or another relative, the tax rules are different, and often much more favorable. Thanks to the “step-up in basis” provision, the cost basis of the property resets to its fair market value on the date of the previous owner’s death.
Suppose your parents bought their house decades ago for $100,000, and it’s worth $700,000 when you inherit it. Your new cost basis is $700,000. If you sell the house soon after inheriting it for $705,000, you’d only owe capital gains tax on the $5,000 difference, not on the $600,000+ gain since your parents bought it.
Why Gifting a Home Before Death Can Be Costly
Some parents consider gifting their home to children before death to avoid probate or for other reasons. This move can backfire from a tax perspective. If you receive a home as a gift during your parent’s lifetime, you also inherit their original cost basis, not the stepped-up value.
Using the previous example, if your parents gift you their $700,000 home (originally purchased for $100,000), your cost basis is $100,000. If you later sell for $705,000, you’ll owe capital gains tax on $605,000, a massive tax bill compared to inheriting and only owing tax on $5,000.
That’s why, from a tax standpoint, it’s usually much wiser to let your parents retain ownership of the house until their death. This ensures you receive the step-up in basis and avoid unnecessary capital gains taxes.
Other Considerations
While taxes are a major factor, they aren’t the only consideration in estate planning. Probate, estate taxes, Medicaid eligibility, and family circumstances may also influence the best strategy for transferring a home. If minimizing capital gains taxes is your goal, inheriting the property, rather than receiving it as a gift during the owner’s life, is almost always the smarter move.
Disclaimer: The information provided on this website is for general informational and educational purposes only and does not constitute tax, legal, or accounting advice. I am not a licensed tax advisor and nothing on this site should be relied upon as tax advice for your specific situation. Tax laws are complex, subject to change, and can vary based on individual circumstances. You are strongly encouraged to consult with a qualified tax professional or advisor before making any decisions or taking any actions based on the information provided here. By using this website, you acknowledge and agree that I am not responsible for any tax consequences that may arise from your use of the information contained herein.