The capital gains tax system can be complicated and obtuse.
But, if you understand the basic concepts the capital gains tax system is built-on, the rest falls into place.
Throughout this guide, you will learn all about capital gains, capital gains taxes, paying capital gains taxes in Texas, and how to avoid paying capital gains taxes entirely.
What Are Capital Gains?
The definition of capital gains is as follows: a profit from the sale of property or an investment.
Just as an example, let’s say you purchase a home for $300,000.
Several years later, after a few notable repairs and a renovation, you sell that same home for $425,000.
By selling the home for that price, you earned $125,000 more than the amount you initially paid for the home.
That’s what capital gains are; selling a property or investment, and making more money than you initially spent to acquire the property/investment.
Anytime you sell a home for more than you initially paid, you will have earned capital gains.
Anytime you earn capital gains, you will need to pay capital gain taxes.
2 Types Of Capital Gains
For every property sale, there is one of two types of capital gains that can apply. Both types of capital gains are taxed in slightly different ways.
Short-Term Capital Gains
The first type of capital gains is known as “short-term capital gains”.
Short-term capital gains are, in the context of selling real estate, the profits you make after selling a home you’ve owned for less than one-year.
If you buy a home for $240,000, sell it six-months later for $280,000, you’ve just earned $40,000 in short-term capital gains.
Every little bit of income that falls into the short-term capital gain you just earned is considered regular taxable income. All of this regular taxable income is subject to the taxation rules of your tax bracket.
Anytime you earn short-term capital gains, you will need to pay income tax on the money you earned.
Long-Term Capital Gains
The second type of capital gains is known as “long-term capital gains”.
Long-term capital gains are the profits you make after owning a home for more than one-year.
If you purchase a home for $300,000, and sell it eight-years later for $500,000, you’ve just earned $200,000 in long-term capital gains.
Tax rates for long-term capital gains are dependent on your income, filing status, as well as whether or not you qualify for a capital gains tax exemption.
Realized Gains & Unrealized Gains
Short-term capital gains and long-term capital gains can fall into one of two categories: realized gains, and unrealized gains.
Realized gains are capital gains that you’ve earned from a completed sale.
Let’s say you purchase a home for $100,000, and then sell that same home for $300,000.
As soon as you complete that sale, you’ve just earned $200,000 worth of capital gains. All of that money is subject to capital gains tax.
But, let’s say that you still own that home. Over the years, it has grown to be worth $300,000 due to fluctuations in the housing market, and you aren’t selling it.
Since you aren’t selling the home, despite the fact that you could do so and earn significant capital gains, your capital gains of $200,000 are “unrealized gains”. The capital gains are unrealized, since there is no tangible profit from a completed sale.
Unrealized gains are, of course, non-taxable, since there is no tangible profit.
The taxes that come with capital gains are only applicable on realized gains that come from a completed sale.
Does Texas Have A Capital Gains Tax?
The short answer to this question is “No”. But, there are a few caveats.
You see, Texas, as a state, does not tax capital gains. You can earn significant capital gains from selling your home, and you won’t have to give the state of Texas any of those capital gains.
But, that being said, the Federal Government does tax any capital gains you earn from selling real estate.
The reason for this is because any real estate you own is considered an “investment property”, and investment properties are taxed at the Federal level.
You can earn significant capital gains on the sale of a property, and some of that must go to the Federal Government. You will not, however, need to pay any state capital gains tax on top of that, though, since Texas does not tax state-earned income.
Capital Assets
The same basic concept applies to anything that is considered a “capital asset”.
Some of the most common capital assets include real estate, stocks, and bonds.
Every single one of those assets is considered a “capital asset”. As such, if you sell one of those assets and earn capital gains, you must pay Federal taxes on those capital gains.
Just like real estate, though, the state of Texas does not require that you pay any capital gain taxes on those assets; only the Federal Government.
If you purchase a home for $250,000, and sell it for $125,000, you’ve earned a capital loss, rather than a capital gain.
Capital Loss
You are not required to pay any capital gains tax, since you’ve sold a capital asset at a capital loss.
The same concept applies not just to real estate, but also other capital assets, such as stocks and bonds.
What Is The Capital Gains Tax Rate?
The capital gains tax rate is meant for people who earn long-term capital gains.
For those who earn short-term capital gains, the capital gains tax rate is irrelevant. All short-term capital gains will be added to your regular income and taxed using the appropriate income tax bracket.
For those who earn long-term capital gains, off of real estate assets that they’ve owned for more than one-year, the tax rates outlined below are indicative of what you should expect to pay.
0% Rate
For single-filers with an income of up to $40,000 per-year, your capital gains will be taxed at 0%.
For taxpayers who file as the head of their household, if you earn no more than $53,600 per-year, your capital gains will be taxed at 0%.
For married taxpayers who file jointly, and earn no more than $80,000 per-year, your capital gains will be taxed at 0%.
For married taxpayers who file separately and earn no more than $40,000 per-year, your capital gains will be taxed at 0%.
If you fall into any one of those filing categories, and earn less than the amount specified, you won’t need to pay any taxes on your long-term capital gains.
15% Rate
For single-filers with an income of anywhere from $40,000 to $441,500 per-year, your capital gains will be taxed at 15%.
For taxpayers who file as the head of their household, if you earn anywhere from $53,600 to $469,050 per-year, your capital gains will be taxed at 15%.
For married taxpayers who file jointly, while earning anywhere from $80,000 to $496,600, your capital gains will be taxed at 15%.
For married taxpayers who file separately, and earn anywhere from $40,000 to $248,300, your capital gains will be taxed at 15%.
If you fall into any of those categories, the long-term capital gains you earn on the sale of your home will be taxed at 15%. You will need to give 15% of the capital gains you earned to the IRS.
20% Rate
For single-filers who earn more than $441,500 per-year, your capital gains will be taxed at 20%.
For taxpayers who file as the head of their household, if you earn more than $469,050 per-year, your capital gains will be taxed at 20%.
For married taxpayers who file jointly, and earn over $496,600 per-year, your capital gains will be taxed at 20%.
For married taxpayers, who file separately and earn over $248,300 per-year, your capital gains will be taxed at 20%.
If you fall into any of those categories, then 20% of the long-term capital gains you earn from selling a home must go to the IRS.
How Can You Avoid Paying Capital Gains?
You can avoid paying capital gains taxes in one of two ways.
If you earn less than the amount of money specified in the 0% capital gains tax bracket, then you will not need to pay any capital gains taxes.
But, if you do not fulfill the tax codes outlined in that bracket, there is another way you can avoid paying capital gains.
The IRS has a specific criteria that, if met and claimed, makes you exempt from paying any capital gains tax on the sale of your home.
Criteria For Not Paying Capital Gains Tax
To not pay capital gains tax, there is a specific criteria that you, and your home, must fulfill.
The home you sold must be your primary residence.
You need to have owned the home for at least two-years.
If you’ve owned the home for longer, you must have lived in the home for at least two-years within the most recent five-year period.
You must not have claimed the capital gains tax exemption within the past two-years on another piece of property.
The final key piece of criteria is dependent on your filing status.
If you are a single-filer, you can earn as much as $250,000 in capital gains from the sale of your home. But, if you earn more than $250,000 from the sale, then you will need to pay capital gains taxes.
If you file jointly, or as the head of your household, you can earn as much as $500,000 in capital gains from the sale of your home. But, as mentioned above, if you earn more than $500,000 in capital gains, then you will need to pay capital gains taxes.
Texas Capital Gains Tax On Real Estate
To further highlight the nature of capital gains tax, three examples are outlined below.
Example 01: Meeting The IRS’ Criteria For A Capital Gains Tax Exemption
A married couple purchases a beautiful Dallas home for $300,000.
For the next five-years, the married couple lives in the home.
Soon after the five-year mark, the married couple decides to sell the home.
Due to fluctuations in the housing market, as well as a few notable repairs, they sell the home for $450,000.
From the sale of their home, the married couple earns $150,000 in capital gains.
Since this married couple owned the home for over five-years, lived in it for more than two-years during that period, and has not claimed the capital gains tax exemption within the most recent two-year period, they pay no taxes on their long-term capital gains.
Example 02: Paying The 20% Rate
A single man purchases a small Dallas home for $145,000.
Just over one-year later, the man chooses to sell the home.
The man sells the home for $185,000, earning $40,000 in capital gains.
Since the man hasn’t owned the home for at least two-years, he is not exempt from paying capital gains tax.
Furthermore, the man earns more than $441,500 per-year, meaning he’ll need to pay a 20% rate on his capital gains.
After the sale, the man pays $8,000 to the IRS, He keeps the remaining $32,000 of his capital gains.
Example 03: Paying The 0% Rate
A man, who earns $40,000 per-year, files as the head of his household, buys a home for $250,000.
Just over one-year later, the man sells the home for $275,000.
Even though the man just earned $25,000 in capital gains, none of that is going to go to the IRS.
The reason for this is because the man does not earn more than $53,600 per-year. If he did, as the head of his household, he would need to pay either 15% or 20%, depending on his earnings.
Short-Term Capital Gains Vs. Long-Term Capital Gains
The three examples outlined above are exclusively for long-term capital gains.
Long-term capital gains are capital gains earned on assets – real estate, in this context – that are sold after being owned for at least one-year.
Short-term capital gains are capital gains earned on assets that are sold after being owned for less than one-year.
Rather than needing to pay a specific capital gains tax rate, short-term capital gains are added to your regular yearly income.
The addition of these capital gains may boost your income tax bracket. Because of this, it’s likely you will need to pay more in taxes, depending on the boost, and how much you usually owe.
Conclusion
In the end, even though capital gains can be tricky, it is remarkably easy to be exempt from paying capital gains tax.
Just make sure you’ve lived in your home for at least two-years, haven’t claimed a capital gains tax exemption within the past two-years, and, depending on your filing status, earn less than $250,000/$500,000.
If you meet those requirements, and are ready to sell your home, you can contact our offices today.
We’ll visit your property, give you a fantastic cash offer, and purchase your home as soon as possible.
The best part is, assuming you meet the requirements outlined above, you won’t need to give a penny of your capital gains to the IRS!
Max Akin Writing 