Capital Gains tax! What is it?

Capital Gains Tax (CGT) is the tax you pay on the profit you make when you sell an asset for more than you paid for it. In real estate, it applies when you sell property for a gain.

1. What Is the “Capital Gain” in Real Estate?

Capital Gain =

Sale Price– Adjusted Cost Basis= Taxable Gain

Adjusted Cost Basis Includes:

• Purchase price

• Closing costs when you bought (title, escrow, recording fees)

• Capital improvements (new roof, HVAC, remodels, additions)

• Minus depreciation (for rentals/investments)

2. Types of Capital Gains

Short-Term Capital Gains

• Property held 1 year or less

• Taxed at ordinary income tax rates (can be high)

Long-Term Capital Gains

• Property held more than 1 year

• Taxed at preferential rates:

  • 0%

  • 15%

  • 20%(depending on income level)

Most real estate sellers fall into long-term gains.

3. Capital Gains on a Primary Residence (Big Exemption)

If the home was your primary residence:

Exclusion Amount

• $250,000 gain (Single)

• $500,000 gain (Married filing jointly)

Requirements:

• Owned the home 2 of the last 5 years

• Lived in it 2 of the last 5 years

• Can use the exclusion once every 2 years

If your gain is below the exclusion, you pay $0 in capital gains tax.

4. Capital Gains on Investment or Rental Property

No primary residence exclusion applies.

You may owe:

1. Long-term capital gains tax (15–20% typically)

2. Depreciation recapture

   • Taxed up to 25%

   • Applies to depreciation taken (or that should have been taken)

This often surprises investors.

5. How Capital Gains Are Calculated (Simple Example)

Purchase Price: $400,000Improvements: $50,000Total Basis: $450,000

Sale Price: $650,000

Capital Gain:$650,000 – $450,000 = $200,000

Now apply:

• Primary residence exclusion → possibly $0 tax

• Or long-term capital gains rate if investment property

6. Ways to Reduce or Defer Capital Gains (Legal & Common)

Primary Residence Exclusion

Best tool for homeowners.

1031 Exchange (Investment Property Only)

• Defers capital gains tax

• Must reinvest into like-kind property

• Strict timelines (45 days identify / 180 days close)

Increase Your Basis

• Document capital improvements

• Keep receipts

Offset With Losses

• Capital losses from other investments

• Real estate losses (if applicable)

7. State Capital Gains Taxes (Important)

Federal tax is only part of the picture.

• Some states have no capital gains tax

• Others tax gains as ordinary income

• California, for example, can significantly increase the total tax bill

8. Common Misconceptions

❌ “I reinvested the money so I don’t owe tax”→ False unless it’s a 1031 exchange

❌ “I didn’t take depreciation so I don’t owe recapture”→ False — IRS assumes depreciation was taken

❌ “Closing costs erase capital gains”→ Only certain costs count toward basis

9. Why This Matters in Real Estate Planning

Capital gains tax:

• Affects pricing strategy

• Determines net proceeds

• Influences hold vs sell decisions

• Can be legally minimized with planning before closing