Capital Gains Tax on Home Sales: Everything You Need to Know
Most net proceeds calculators completely ignore taxes, and that is a costly mistake. A $650,000 home sale can trigger a $40,000+ tax bill between federal capital gains, the Net Investment Income Tax, and state taxes. Yet most sellers do not discover this until they are sitting at the closing table. If you want to know exactly what you owe before you list, a capital gains tax home sale calculator is the single most important tool in your arsenal.
This guide covers every angle: the $250K/$500K exemption, federal and state rates, depreciation recapture, and five proven strategies to minimize your bill. If you already know the basics and want your specific number, calculate your tax liability with our free TaxMap calculator.
Do You Owe Capital Gains Tax? The Exemption Test
The good news is that most primary residence sellers owe zero federal capital gains tax thanks to the Section 121 exclusion. Here is how it works:
- Single filers can exclude up to $250,000 in capital gains from their home sale
- Married filing jointly can exclude up to $500,000
To qualify, you must pass two tests:
The Ownership Test: You owned the home for at least 2 of the 5 years before the sale date. The two years do not need to be consecutive.
The Use Test: You lived in the home as your primary residence for at least 2 of the 5 years before the sale date. Again, the two years do not need to be consecutive.
The Frequency Rule: You have not used the Section 121 exclusion on another home sale in the past 2 years.
Tax-Free Exclusion
$250K / $500K
for single filers / married filing jointly on primary residence sales
Quick Decision Flowchart
Ask yourself three questions in order:
- Did you own AND live in the home for at least 2 of the last 5 years? If no, you likely owe tax on the full gain (partial exclusions may apply in some cases).
- Is your gain under $250,000 (single) or $500,000 (married)? If yes, you owe $0 in federal capital gains tax. You are done.
- Is your gain above those thresholds? Then you owe tax only on the amount above the exclusion.
Common Disqualifiers
Watch out for these situations that reduce or eliminate your exclusion:
- Rental conversions: If you converted your primary residence to a rental, gains attributable to depreciation taken after 2008 are NOT excludable, even if you meet the 2-of-5 year test.
- Less than 2 years of residence: You may qualify for a partial exclusion if you moved due to job change, health reasons, or unforeseen circumstances.
- Investment properties: The Section 121 exclusion does not apply to investment or rental properties you never lived in.
- Recent exclusion use: If you used the exclusion on another sale within the past 2 years, you cannot use it again.
Federal Capital Gains Tax Rates for Home Sales in 2026
If your gain exceeds the exclusion (or you do not qualify), here is what you will pay at the federal level.
Short-Term vs Long-Term
Short-term capital gains apply if you owned the home for less than one year. These are taxed as ordinary income at rates of 10%-37%, which is significantly more expensive.
Long-term capital gains apply if you owned for more than one year. These enjoy preferential tax rates:
| Filing Status | 0% Rate (Income Up To) | 15% Rate (Income) | 20% Rate (Income Over) | |---|---|---|---| | Single | $47,525 | $47,526 - $518,900 | $518,900 | | Married Filing Jointly | $95,050 | $95,051 - $583,750 | $583,750 | | Head of Household | $63,000 | $63,001 - $551,350 | $551,350 | | Married Filing Separately | $47,525 | $47,526 - $291,850 | $291,850 |
Most home sellers fall into the 15% bracket for their taxable gains.
Net Investment Income Tax (NIIT): The Extra 3.8%
On top of the standard capital gains rate, an additional 3.8% Net Investment Income Tax applies if your modified adjusted gross income exceeds:
- $200,000 for single filers
- $250,000 for married filing jointly
- $125,000 for married filing separately
This pushes the effective federal rate to 18.8% for most affected sellers, or 23.8% for those in the top bracket.
Real-World Example
A married couple sells their home for $850,000. They bought it for $350,000 and made $50,000 in capital improvements. Their gain is $850,000 - $400,000 = $450,000. Since they are married, the full $450,000 is under the $500,000 exclusion. Federal tax owed: $0.
Now consider a single seller with the same numbers. The exclusion is $250,000, so the taxable gain is $450,000 - $250,000 = $200,000. At the 15% rate plus 3.8% NIIT (assuming income over $200K), the federal tax bill is $200,000 x 18.8% = $37,600.
State Capital Gains Tax: The Second Bite
Federal taxes are only part of the story. Most states impose their own tax on capital gains, and the rates vary dramatically. Here is a breakdown:
States With No Capital Gains Tax (0%)
| State | Notes | |---|---| | Alaska | No state income tax | | Florida | No state income tax | | Nevada | No state income tax | | New Hampshire | No tax on earned income; interest/dividend tax repealed 2025 | | South Dakota | No state income tax | | Tennessee | No state income tax (Hall Tax repealed 2021) | | Texas | No state income tax | | Wyoming | No state income tax |
Highest Capital Gains Tax States
| State | Top Rate | Applies To | |---|---|---| | California | 13.3% | Income over $1M (no special rate for cap gains) | | Hawaii | 11.0% | Capital gains taxed at 7.25% below $48K, 11% above | | New Jersey | 10.75% | Income over $1M | | Oregon | 9.9% | Income over $125K (single) | | Minnesota | 9.85% | Income over $183,340 | | New York | 10.9% | Income over $25M (8.82% for most; NYC adds 3.876%) | | Vermont | 8.75% | Income over $229,550 | | Iowa | 8.53% | Flat rate on all capital gains | | Wisconsin | 7.65% | Income over $280,950 | | Maine | 7.15% | Income over $58,050 |
Washington State: A Special Case
Washington does not have a traditional income tax, but in 2022 enacted a 7% excise tax on capital gains exceeding $250,000. This applies to long-term capital gains from sales of stocks, bonds, and certain other assets. Real estate sales are generally exempt, but gains from selling a primary residence that exceed the federal Section 121 exclusion could be subject to this tax. Consult a Washington-state CPA for specifics.
Combined Federal + State Example
A California seller with $100,000 in taxable gain (after the Section 121 exclusion) with income over $200K:
| Tax Component | Rate | Amount | |---|---|---| | Federal long-term capital gains | 15.0% | $15,000 | | Net Investment Income Tax (NIIT) | 3.8% | $3,800 | | California state tax | 13.3% | $13,300 | | Total tax bill | 32.1% | $32,100 |
That is nearly a third of the taxable gain consumed by taxes. See your state's full tax breakdown or check Texas (no state tax) for comparison.
Investment Properties: The Depreciation Trap
If you are selling a rental or investment property, the tax picture is significantly worse.
No $250K/$500K Exclusion
The Section 121 exclusion is only for primary residences. Investment properties get no exclusion, meaning the entire gain is taxable from dollar one.
Depreciation Recapture at 25%
If you claimed depreciation deductions on a rental property (and you should have, since the IRS treats it as mandatory), you must "recapture" that depreciation at a 25% federal rate. This is higher than the standard 15% long-term capital gains rate and applies regardless of your income bracket.
1031 Exchange: Deferring, Not Avoiding
A Section 1031 like-kind exchange allows you to defer capital gains taxes by reinvesting the proceeds into another investment property. Key rules:
- You must identify replacement properties within 45 days of closing
- You must close on the replacement within 180 days
- The replacement must be of equal or greater value
- You cannot receive any "boot" (cash) from the transaction
Investment Property Example
You sell a rental for $500,000 that you purchased for $300,000 ten years ago. You claimed $90,000 in depreciation over that period.
| Component | Calculation | Tax Rate | Tax Owed | |---|---|---|---| | Depreciation recapture | $90,000 | 25% | $22,500 | | Remaining capital gain | $110,000 ($200K gain - $90K depreciation) | 15% + 3.8% NIIT | $20,680 | | Total federal tax | | | $43,180 |
Add state taxes and this sale could trigger $50,000-$60,000+ in total tax liability.
5 Strategies to Reduce Your Capital Gains Tax Bill
1. Maximize Your Cost Basis
Your cost basis is not just what you paid for the home. It includes:
- Purchase price plus closing costs you paid as a buyer
- Capital improvements (new roof, kitchen remodel, additions, landscaping)
- Special assessments for local improvements
Keep every receipt. A $50,000 kitchen remodel reduces your taxable gain by $50,000, saving you $9,400+ in federal taxes alone at the 18.8% combined rate.
Important: Repairs and maintenance (painting, fixing leaks, replacing broken fixtures) do NOT increase your cost basis. Only improvements that add value, extend the life, or adapt the home to a new use qualify.
2. Use the 2-of-5 Year Rule Strategically
If you converted a rental property to your primary residence, you can establish the 2-year use period and then sell with the Section 121 exclusion. The timing is critical: you must live in the home for at least 2 of the 5 years preceding the sale.
If you are close to the 2-year mark, waiting a few months to sell can save you the entire tax bill on up to $250K/$500K in gains.
3. Consider a 1031 Exchange for Investment Properties
If you are selling a rental or investment property and plan to buy another, a 1031 exchange defers your entire tax bill. Many investors chain 1031 exchanges throughout their lifetime and eventually pass properties to heirs, who receive a stepped-up cost basis that eliminates the deferred gains entirely.
4. Harvest Losses in Other Investments
Capital losses from stocks, bonds, or other investments can offset capital gains from your home sale. If you have losing positions in your investment portfolio, selling them in the same tax year can reduce your home sale tax bill dollar for dollar.
5. Consult a Tax Professional for Complex Situations
The strategies above can interact in complex ways, especially when combined with state taxes, NIIT, and AMT considerations. A CPA who specializes in real estate can often identify savings that far exceed their fee. For sales with taxable gains over $100,000, professional advice is almost always worth the investment.
Frequently Asked Questions
How do I calculate capital gains on my home sale?
Subtract your cost basis (purchase price + improvements + buying closing costs) and your selling costs (commission, closing costs) from your sale price. The result is your capital gain. Then subtract the $250K/$500K exclusion if you qualify. Any remaining amount is your taxable gain, subject to federal and state capital gains tax rates.
What counts as an improvement vs a repair?
Improvements add value, extend the home's life, or adapt it to a new use. Examples: new roof, kitchen remodel, room addition, new HVAC system. Repairs maintain the home in its current condition. Examples: patching a roof leak, painting, fixing a broken window. Only improvements increase your cost basis.
Can I avoid capital gains tax if I reinvest in another home?
Not directly. The old "rollover" provision was eliminated in 1997. Today, the Section 121 exclusion is your primary tax break for primary residences. For investment properties, a 1031 exchange allows you to defer (not avoid) taxes by reinvesting in a like-kind property.
What if I inherited the property?
Inherited property receives a stepped-up cost basis equal to the fair market value at the date of the decedent's death. This means if you inherited a home worth $500,000 and sell it for $520,000, your taxable gain is only $20,000, not the difference from the original purchase price decades ago. This is one of the most powerful tax advantages in real estate.
Do I have to report the sale to the IRS even if I owe no tax?
If you receive a Form 1099-S from the closing agent, you must report the sale on your tax return. However, if your gain is fully excluded under Section 121, you will not owe any tax. Many title companies now issue 1099-S forms for all sales, so plan to report it regardless.
The Bottom Line
Capital gains tax is often the largest overlooked cost of selling a home. For sellers in high-tax states like California or New York, the combined federal and state tax bill can exceed 30% of the taxable gain. But with proper planning, most primary residence sellers can eliminate their tax liability entirely through the $250K/$500K exclusion. Use our free TaxMap calculator to see your exact federal and state exposure before you list. Knowing your tax situation in advance can save you tens of thousands of dollars and eliminate one of the biggest surprises in the home selling process.