I recently had someone ask me if there is a way to avoid paying capital gains and I thought this was a great question, so I wanted to talk about it here.
Let’s break this down.
What Are Capital Gains?
There are two types of taxes that most of us generally have to deal with. There are the normal income taxes and capital gains taxes. They are two different things.
Capital gains are the profits that an investor sees from an investment at the time that investment is sold. The capital gains tax is applied to that profit and is owed when the investment is sold.
When it comes to investments, there are two kinds of capital gains. There are short-term capital gains that apply to investments that have been held for under a year and long-term capital gains that apply to investments that have been held for a year or longer.
How Do Capital Gains Apply To Houses?
Houses are an investment. Over time they appreciate in value. Generally, this means that when you sell your house, you will be able to sell it for more than you bought it for, especially if you have had it for a while.
The person who asked this question had a really unique situation. She bought a house and realized that she did not like it and wanted to move within her first year there. Under normal circumstances, a house would not appreciate enough in one year for someone to be able to realize any profits, meaning that the capital gains tax would not apply.
However, in the past year, we have seen ridiculous appreciation. Home values in 2022 have increased 21.8% from 2021. Prior to the pandemic, the average appreciation rate of home values in the US was just 4%.
In a market where houses appreciate nearly 22% in a year, it is certainly possible to see profits on houses bought and sold within the same year.
Can I Avoid Capital Gains?
I reached out to a company that we talked about a couple weeks ago that specializes in 1031 exchanges. I figured if anyone would know, it would be them.
The 1031 exchange allows you to defer your capital gains if you invest that money into another property. This was my initial thought as to how she might be able to avoid paying her capital gains tax. Unfortunately, this is only allowed on investment properties. You cannot do a 1031 exchange for a personal property that you are living in.
This could be an option if she decided to rent her property out for a little bit. This isn’t particularly ideal because she would need to find a place to live without the money that she will gain from selling her property.
If you are selling your personal property, you don’t have to pay capital gains up to a certain amount. This amount varies depending on your situation. If you file as a single person, you can avoid capital gains of up to $250,000. If you’re married, you can avoid up to $500,000. You must live in the house for at least two of the last five years to see this benefit. When most people sell their homes, they usually don’t have to pay capital gains taxes because of this.
Capital gains are not usually a significant issue when it comes to selling houses, especially personal properties. However, every now and then a unique situation arises where they are an issue. If you are in one of these unique situations I would recommend reaching out to a CBA to help you find the best course of action. Taxes can be complicated and professionals are the best equipped to help you find the right solution.
If you have any questions, please feel free to contact us through our website.