Tax Penalty for Selling House before 2 Years – Here’s What You Need to Know

By: ROS Team

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You’ve taken all the detailed measures, done all the searches for the best house, and you’ve negotiated and made arrangements to get the house inspected to finalize the buying process. Now you are entering the real estate market again, less than two years later, but this time as a seller.

Do you know there is a tax penalty for selling a house before 2 years? Read on to learn about the penalty for selling a house within two years.

Potential Downside of Selling a House Before 2 Years

If you sell your home before you’ve owned it for at least two years, you’re less likely to earn much of a profit when it sells.  That may not necessarily be the case if you opt to sell the property at a higher price than the purchase price, but you still won’t maximize potential profits.

When you buy a home, you pay funds that are applied directly to the home loan’s interest. That is why you will need some time to build equity in the property during your loan term, regardless of the payment amount. In addition, if you get assistance from a real estate agent to sell the property, you will need additional funds for agent fees and commission.

Ideally, your home’s value will have increased from the date you bought it. Otherwise, if your home lost value, you run the risk of selling it at a loss.

What Are Capital Gains and What Does It Mean?

Capital gains are the increases in the value of a property from the date it was purchased.  For instance, if a property was purchased for $150,000 and later sold for $210,000, the total capital gain on that property is $60,000. If the capital gains amount exceeds the threshold, you will be asked to pay taxes.

Capital Gains Taxes on Real Estate

According to Internal Revenue Service (IRS) rules, tax exemption is provided only to houses that serve as the owner’s primary residence. In addition, only the owner’s personal property is exempted from the tax duty owed in the last two years.

Capital Gains Taxes

If you purchased a house, the value increases over time and you decide to resell it for a profit. The sale is not exempt from taxes and you must pay capital gain tax.

Or, if you bought the property and decide to sell it after two years. Then there is a possibility that you may have to pay taxes if the profit earned on the sale of the property exceeds the IRS threshold.

The criteria to meet the threshold are:

  • You are single and the sale results in a profit of more than $250,000; or
  • You are married and the sale results in a profit of more than $500,000.

Ways to Avoid Paying Taxes While Selling Your Home

The easiest way to avoid paying taxes on your property is to own it for at least two years. If you must sell the property within two years of buying it due to work relocation or health reasons, consider alternatives to selling it.

A popular alternative is renting it out once you vacate the premises. With this method, you will have an income stream to help cover the cost of the home loan for two years while avoiding the tax penalty.

Once you’ve owned the property for at least two years, you will have a little more flexibility about whether or not to sell without having to factor in a potential tax penalty. You can also continue renting out your home if you think doing so is a more suitable and profitable way of generating money. You can hire an accountant and a real estate agent to gain better insight regarding this issue so that you make the decision that’s best for you.

When is a Home Fully Taxable

Every property owner won’t qualify for a tax exemption. In order to qualify, home sales is fully taxable when:

  • The property was purchased through 1031 Exchange within the last five years. 1031 Exchange helps you avoid paying capital gain tax if you sell the property and reinvest the proceeds under the limits of the U.S. Internal Revenue Code;
  • The home is not the primary residence of the seller;
  • For at least two of the last five years, the seller didn’t use the property as a primary residence; or
  • The seller has already taken advantage of the capital gain exclusion within the last two years.

 

Note: If any of the above conditions are met, the sale of a home is subject to being fully taxable.

How Much Time Do You Need to Buy Another House to Avoid Taxes?

There is no time requirement for buying a new house in order to avoid paying capital gains taxes.

Is It Possible to Sell One House and Avoid Paying a Tax Penalty by Listing it as an Investment Property?

The Rule of 1031 Exchange allows investors to sell a house and buy a new one within 180 days of the sale. Otherwise, if you are not an investor, there is no way to avoid paying the tax penalty except if you’ve owned the property for at least two years.

As previously mentioned, if an investor wants to qualify for a Rule 1031 exemption, he or she must find and close on another rental property within the allotted 180 day period; otherwise, he or she will be required to pay the capital gains tax on the profit earned from the sale.

Difference Between Long Term and Short Term Capital Gains

Capital gains are further classified into short-term and long-term capital gains. If you have owned a home for a year or less, you will be required to pay a short-term capital gains tax that is almost equivalent to the income tax rate. On the other hand, if you’ve owned your home for more than a year. You will be required to pay a long-term capital gains tax, which is about 20% of the total tax rate.

Are You Required to Own a House for Five Years to Avoid Paying Capital Gains Taxes?

There is no requirement that you have to own a house for five years to avoid paying capital gains taxes. If you’ve lived in the house for two years of the last five years, you are eligible for the tax exemption. Moreover, if your profit margin exceeds $250,000 or $500,000 when you sell the property. You will likely be required to pay some amount of capital gain tax.

The Amount of Capital Gains Taxes Required When Selling a Home

If you are asked to pay capital gains taxes, the amount owed will depend on your household income and the length of time you owned the house. If you sell your home before the two years, you will be required to pay short-term capital gains taxes which are charged as the income tax rate. As the length of property ownership increases after two years, you will qualify for the long-term capital gains tax, which will be 20% or less than the short-term capital gains tax amount depending on your income.

Can a Person Buy Two Primary Residences to Avoid Paying Capital Gains Taxes?

Even though you may be able to buy two homes and you spend time living in both, only one of the properties will be considered your primary residence. You will only get an exemption on one of your properties if you have lived in it for two years. You will not be exempted from paying capital gains taxes on your secondary residence.

Is It Possible to Partially Qualify for a Tax Exemption?

If you must sell your house within two years of buying it and don’t have time to wait, you may qualify for an exemption from the tax penalty. You should consult with an accountant who may be able to assist with finding partial tax exemptions depending on the scenario.

Final Takeaways

It is evident that selling a house before 2 years hardly goes in the favor of the seller. Those who purchased a house with a home loan are less likely to build enough equity in the house in two years to earn any real profit.

In addition, two years is not enough time for the property to gain capital. But if you happen to be a wholesale dealer or have a big real estate investment portfolio, you may be able to sell the property and only have to pay a short-term capital gains tax.

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