Single homeowners can exclude up to $250,000 of capital gains on the sale of their primary residence, and married couples filing jointly can exclude up to $500,000. To qualify, you must have owned and lived in the home for at least 2 of the last 5 years.
Most homeowners do not pay capital gains tax because their gain falls within the exclusion limits.
The 2-out-of-5-Year Rule
To qualify for the capital gains exclusion, you must have owned the home for at least 2 years and lived in it as your primary residence for at least 2 of the last 5 years. The 2 years do not have to be continuous. You can also claim a partial exclusion if you sell due to a change in employment, health reasons, or unforeseen circumstances.
Calculating Your Gain
Your capital gain is the sale price minus your cost basis. Cost basis includes what you paid for the home plus the cost of improvements (not repairs) made over the years. Keep records of all capital improvements like a new roof, HVAC replacement, kitchen renovation, or addition, as these increase your basis and reduce your taxable gain.
When Capital Gains Tax Applies
If your gain exceeds the exclusion limit, the excess is taxed as a long-term capital gain at rates of 0%, 15%, or 20% depending on your income. Texas has no state income tax, so you only owe federal capital gains tax. If you have not lived in the home for 2 years or have used the exclusion on another home sale within the last 2 years, the full gain may be taxable. Consult a tax professional for your specific situation.
