Capital gains tax USA property occurs when an asset is sold for more than what was paid to acquire it. This usually happens from the sale of an investment, but it also applies to personal property. For example, a capital gain is most commonly associated with the sale of stock or property.

What Are the Requirements to Avoid Paying Capital Gains Tax?

The requirements to avoid paying capital gains tax on real estate include:

  • The property must be your principal residence
    • You reside on the property
    • Cannot be a property used solely for investment purposes
  • Must have resided at the property for at least two of the five years before it was sold
    • Referred to as “the use test”
    • Each sale must be at a minimum of two years apart

In other words, the Internal Revenue Service (IRS) allows property owners to sell their primary residence every two years tax free, when the gain is less than $500,000 for a married couple filing jointly.

What's the Housing Assistance Act of 2008?

With the updated tax laws, owners of multiple properties may find it increasingly difficult to shelter profits. The Housing Assistance Act (HAA) of 2008 was designed to prevent real estate owners with more than one property from taking advantage of the tax-free loophole.

In the past, property owners took advantage of this loophole by moving every two years from one residence to the next, never paying capital gains tax. Under the new law, even if property owners convert their second piece of real estate to their primary home, they'll still owe tax on a part of the revenue based on how long the property was used as a second residence.

Special Rules for Married Couples in Paying Capital Gains Tax

While spouses receive about double the tax exemption of single filers, couples may have to consider additional circumstances to qualify their sale as tax-free. One of the spouses must pass the ownership requirement. This means that if only one person has lived in the primary property for six months, but the other has lived in the property for the last two years, then both parties will meet the ownership requirement because at least one person met the requisite timeframe.

Both spouses will need to pass a residence requirement test. Unlike the ownership requirement, each spouse must pass the residence requirement individually for a married couple filing jointly to receive the full exclusion. To clarify, each person must have lived in the residence for at least two years. For example, if a couple shared a home for one year prior to getting married and then one year as newlyweds, the IRS would grant the exemption. However, if one spouse didn't move into the residence until after the wedding day, the tax-exemption will not qualify.

In cases where one spouse has recently sold a property, and used the full exclusion within the last two years of the sale of any property that was jointly-owned, the couple cannot claim the exclusion. In other words, if one spouse sold a primary residence six months prior to the wedding, then they'll need to wait an additional one and one-half years subsequent to the earlier sale date before they are eligible to sell their new residence tax-free. In many cases, couples may only be able exclude a certain amount of the profit from tax, based on the eligibility criteria.

Special Rules for Members of the Military

There are special rules for members of the military. During wartime, many soldiers were being deployed numerous times making it challenging for them to meet the residency rule. Not meeting the requirement, they were forced into paying more taxes than was most likely fair. An exemption to the use rule was provided to military members starting in 2003.

Short-Term Capital Gains vs Long Term

Capital gains tax rates vary based on whether they're short or long term. Real estate investors that hold onto a property for one year or less prior to selling will have to pay a short-term capital gains tax. Real estate investors that hold onto a property for more than one year prior to selling will have to pay a long-term capital gains tax.

The current long-term capital gains rate is based on income brackets, but is generally anywhere between zero and 20 percent. Recent tax reform changes are suggesting that long-term capital gains may increase in the future. Property owners may take advantage of the IRS capital gains exclusion by selling a home that has been their primary residence for at least two years.

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