Capital gains taxes can cut into your real estate profits after selling a property. Although Texas doesn’t charge state-level capital gains taxes, those who sell a house may still be subject to federal capital gains taxes.
Paying capital gains taxes is required if you profit from selling real estate, whether it’s a primary residence or investment property.
This guide reviews capital gains taxes, including who pays capital gains tax and when. We’ll also consider a few exemptions and strategies to help limit your tax liability and keep more hard-earned dollars in your pocket.
What are Capital Gains Taxes?
Capital gains taxes are fees or taxes you pay on the profits of an investment. Capital gains are required for profits earned from stocks or real estate. Anyone who earns capital gains through the sale of a property or asset in Texas must pay a capital gains tax at the federal level.
Understanding capital gains taxes is important if you plan to sell property in Texas. Capital gains tax rates vary depending on the state, sale price, and income. Your capital gains tax rate may also be affected by how long you have owned the property and whether or not it was your primary residence.
Texas and Capital Gains
Most home sales trigger a capital gains tax. However, with state and federal-level exclusions, reducing your tax obligations is possible. Here are a few things to know about Texas and capital gains.
No State-Level Capital Gains Tax
Texas is only one of eight U.S. states that don’t require a capital gains tax. The federal tax capital gains tax rate on the sale of a Texas property will depend on taxable income, filing status, and exemption eligibility.
Federal Capital Gains Tax Applies
A federal capital gains tax applies to all home sales in Texas. Capital gains tax liability depends on the property’s sale value and how long you held the asset. Your taxable income also affects how much you pay in federal taxes.
Long-term capital gains are 0%, 15%, or 20%. Long-term federal capital gains amounts also depend on your income and change annually based on tax law updates. Sellers who have lower income levels may qualify for an income-based exemption. Holding an asset for less than one year will trigger short-term capital gains obligations, which are taxed at a higher rate.
When Do I Have to Pay Capital Gains Tax on Home Sale in Texas?
Sellers never have to pay state capital gains tax on the sale of a home in Texas. However, you are still subject to federal long- and short-term capital gains taxes. These capital gains taxes are due annually, but the IRS often requires capital gains tax payments to be paid quarterly.
The quarterly tax schedule consists of the following:
- First quarter: By April 15
- Second quarter: By June 15
- Third quarter: By September 16
- Fourth quarter: By January 15
The IRS sometimes requires quarterly capital gains taxes to be paid by investors. Failing to meet these quarterly filing timelines can lead to additional fees and penalties on top of the capital gains tax.
Capital Gains Tax on Primary Residence
There is no time limit for when you will pay capital gains taxes on a property that you sell. What does matter is how long you have held the property. The short-term capital gains tax rate will be applied if you have owned it for less than a year. This rate is the same as the usual federal taxable income rate.
If you hold the property for a year or more, the long-term capital gain rates will apply, which fall between 0% and 20% for the most part. In general, long-term gains are taxed at a lower rate than short-term gains.
The property type you sell affects how much you owe in capital gains. A primary residence is a property that you call home for the majority of the year. It’s also where your driver’s license, insurance policies, and bank statements are registered. To qualify for the primary residence exemption, you must also live on the property for most of the year.
Certain tax exemptions are available to those who triggered capital gains taxes on a primary residence, including the following Section 121 exemption.
Section 121 Exclusion
The Section 121 exclusion allows eligible sellers to avoid capital gains taxes on the sale of a primary residence up to a certain amount. This primary residence exemption can lead to significant cost savings, especially when married filing jointly.
Eligibility Requirements
You must meet certain eligibility requirements to qualify for the Section 121 exclusion, including length of time at the property. Qualifying for Section 121 exclusion requires that you have owned the home for at least two of the last five years and have lived in the home as your primary residence for at least two of the last five years.
Additionally, Section 121’s primary residence exemption can be used every two years, making it a desirable strategy for investors. Holding the property for over one year and living in it while making necessary repairs and renovations means you can qualify for long-term capital gains tax benefits.
Exclusion Limits
The Internal Revenue Service (IRS) sets limits on the primary residence tax exclusion, which include the following:
- Up to $250,000 exemption for single filers.
- Up to $500,000 exemption for married filing jointly.
Claiming this exemption is easy and can be done on your normal income tax filing. Discussing your taxable obligations with a tax advisor if you have questions about your income tax rate or filing status can be helpful. A tax or financial advisor can also help choose the appropriate federal tax forms to ensure you qualify for all potential tax savings.
Partial Exclusions
Even if you don’t meet the full list of requirements for Section 121, you may still be eligible for a portion of the exemption. Your capital gains exclusion amount can be prorated based on the amount of time you lived in the property as your primary residence. Depending on how long you lived at the property, even a partial tax exemption could result in significant capital gains tax deductions.
Capital Gains Tax on Investment and Secondary Properties
Investment and secondary properties are often taxed at a higher rate. Your income tax rate may be higher due to the profits earned from the property. Additionally, investors are more likely to hold onto an investment property for less time, triggering more expensive short-term capital gains.
If you plan to hold onto a property for less than a year, it’s important to calculate your short-term capital gains ahead of time to accurately predict your profits.
No Primary Residence Exclusion
Investment properties are not eligible for long-term capital gains exemptions, including the Section 121 exclusion. However, even investment properties in Texas are excluded from state capital gains taxes. Additionally, there are strategies available to minimize your capital gains tax rate or defer capital gains taxes.
Holding on to your non-primary residence is one strategy that can help avoid high net capital gains. Long-term capital gains are typically taxed at a lower rate than short-term gains, regardless of whether or not it’s your primary home or a rental property.
Calculating Capital Gains
Calculating your capital gains can help you better understand your tax liabilities. The Internal Revenue Service requires that you report capital gains tax liabilities based on an adjusted basis.
Adjusted Basis = Original Purchase Price + Improvement – Depreciation
The adjusted basis is the price you paid for the asset plus improvements and minus depreciation. You can include any capital improvements on an adjusted basis, including a new roof or addition to the home. You can not, however, include ordinary home repairs on an adjusted basis.
Depreciation is the expected loss of value that occurs on properties over time. The Internal Revenue Service allows you to deduct a certain portion of expected depreciation each year.
You can then calculate your net capital gain based on the sale price minus any selling costs. Common selling costs include real estate commissions, transfer fees, appraisal, and inspection costs.
Your capital gain tax burden is the proceeds from the sale minus the adjusted basis. Then, consider your tax rate for the current income year, which will determine whether you owe 0%, 15%, or 20% federal capital gains tax.
Of course, you also want to consider any capital gains exemptions that may be available to you.
Some sellers may also qualify for income-based exemptions. Certain income thresholds will qualify for 0% capital gains based on the current year’s tax bracket and ordinary income tax rate.
Tax Rates
The IRS also requires filers to pay capital gains taxes based on the length of time they held an asset. Accurately calculating capital gains tax rates requires considering your selling timeline.
Short-term investments are assets that were purchased and sold within one year or less. Short-term capital gain tax rates are calculated based on ordinary income and are higher than long-term rates. Short-term capital gains tax rates range between 10% and 37% but change each year based on the current tax code.
Long-term investments are assets you hold for more than a year, and rates depend on ordinary income. Long-term capital gains are taxed at either 0%, 15%, or 20%, depending on your income. The lower capital gains tax is designed to encourage investors to hold properties longer.
If your taxable income is less than or equal to the following, you may qualify for a 0% capital gain rate:
- $44,625 for single or married filing separately.
- $89,250 more married filing jointly.
- $59,750 for head of household
You must pay capital gains taxes at a higher rate if your income exceeds these limits. Your income tax bracket may adjust your liabilities into a 15% or 20% capital gains tax rate. Of course, your filing status also affects the ordinary income rate you pay.
Other Relevant Factors
Understanding capital gains tax is important when you plan to sell your home. Some selling situations can trigger high capital gains and cut into your profits. Here are a few additional considerations regarding capital gain taxes in Texas.
Depreciation Recapture
Claiming depreciation on an investment property can help limit your capital gains tax burden. However, when selling the property, you may be required to repay any recapture benefits, also known as a depreciation recapture tax.
Tax laws are continually changing, and taking advantage of available exemptions could have future tax implications. For this reason, it’s important to discuss your capital gains taxes and strategies with a tax professional to avoid any unexpected expenses.
Selling Expenses
You can deduct selling expenses from your capital gains tax liability. Selling a house commonly requires paying realtor commissions and closing cost fees. Deducting these costs from your capital gains can significantly reduce your taxable liability and avoid capital gains tax obligations that cut into your profits.
When selling a rental property, you may qualify for even more deductions. Deduct management and maintenance costs to minimize your annual taxable income.
Capital Losses
Not all assets earn money. Fortunately, you don’t have to pay taxes on assets that you sell for less than the original purchase price. Be sure to include capital losses on your tax filing, just as you would report the gains from capital assets.
For example, if you purchase a property that requires extensive repairs, you may incur a loss if you try to sell it in the next couple of years. Without any capital gains, you won’t owe a percentage of your profits because there aren’t any.
Reporting capital losses doesn’t just affect your capital gains tax liability on that specific property but can also be used to offset other gains. Tax law allows you to use the capital losses to offset other asset’s capital gains tax liability. Even if you don’t have current capital gains obligations, you can often carry forward the losses for future capital gains.
Final Thoughts
Income or profits earned from Texas property sales is taxable. However, selling real estate in Texas is desirable, as there are no state-level capital gains tax requirements. You can minimize your taxable liability by avoiding income taxes on your Texas property sales.
Some sellers may also be able to avoid federal capital gains tax obligations by taking advantage of certain exemption programs. Calculating capital gains tax requirements beforehand helps you plan and choose the appropriate exemptions for your situation.
Interested in selling your existing asset without incurring expensive commissions and fees? Contact A-List Properties today at 972-526-7042 to learn how to leverage the sale of your property to improve your financial position. Our team is experienced in Texas state tax laws, and we can help you navigate your home sale.
Zach Shelley
Zach Shelley is a seasoned real estate investor with a diverse network spanning across the nation. As the founder of his own real estate venture, Zach is committed to offering innovative solutions to homeowners facing various real estate challenges.. Through his dedication and strategic approach, Zach continues to make a significant impact in the real estate industry, providing homeowners with alternative pathways to navigate their property transactions.
