Capital gains is the profit a homeowner makes when they sell a piece of property for a profit. The gain is the difference between what they owed on the home and at what price the home was sold.
For instance: if a homeowner has a $200,000 mortgage on a piece of property and cells that property for $300,000 they've made $100,000 in capital gains profit. There is a tax on that profit that sellers must pay unless they are exempt or excluded based on their marital status and the amount of profit. Individual homeowners can exclude up to $250,000 in the profit from the sale of the home and married couples can exclude up to $500,000. However, this is only acceptable if the homeowner has lived in the home and owned it for a minimum of two years. These two years do not have to be consecutive but in the five years prior to the sale of the house, homeowners must have occupied the property for at least 24 months within that five-year period. There are certain exceptions such as selling the house because of a relocation or mandatory job change, medical concerns or other unforeseen circumstances. In which case, many times these sellers will use a "short sale" to sell the property, but this is really only used in cases where the homeowner owes more on the property in the home is worth. The IRS gives unique examples of unforeseen circumstances such as natural disasters, acts of war or terrorism, changes in unemployment, death or divorce.
If you're selling your home and your profit is over the excluded amount you take the sale price of the property and subtract the basis which includes any remodels, home improvements or significant capital improvements you may have made over the years. This can be difficult so keeping receipts on home improvements is important. Once subtracted from the sale price of the home you should be able to figure out exactly how much profit you'll gain from the sale of your home. This is extremely important especially in situations where the home is owned free and clear. Once you understand what the difference is then you can use the federal and state rate to calculate the amount of tax.
In cases where you have not owned a home for the recommended time or you have owned a rental property, there are certain exclusions and exceptions in which you won't have to pay capital gains taxes. One option is to simply roll the profits into a new investment property in which case you would use a 1031 tax exchange form. You are simply exchanging the tax from one property to another. Capital gains can be avoided altogether in this case if you eventually live in the investment rental for two years and then sell. Otherwise, if you sell for profit and do not reinvest in another property you will most likely have to pay capital gains taxes.
For more information on the capital gains exclusion or for rolling one property's profits into another's please give me a call.