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Income tax when selling a house Question
When an ordinary person sells their house in the US, what happens to their tax situation? Usually, houses sell for half a million and up, and considering also regular (ie. salary) income, this would put one's income at a very high level for that year. Since the government taxes around 40% at higher brackets, does that mean that when you sell your house the government takes ~30-40% of that money?
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No, because you get to account for the basis.
If you bought a house at \$300k and later sold it for \$500k, then only the $200k profit is under consideration for income taxes. Further, the federal government taxes regular income (like your salary) and longer-term investment income at different rates. I do not know if house-sale proceeds are long-term capital gains or a different category (it's been a while since I sold a house), but it's not the same rate as salary.
(I very much hope that someone will provide a better answer that supersedes this one.)
In the common case of selling a house and buying a house (you still need a place to live, after all), you can also use the tax benefits from the purchase to mitigate the tax impact of the sale, if both events happen in the same tax year.
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In US income tax system, your home is an asset referred to as "capital". When you sell your house, you might pay income tax based on your profit from the house. The tax terminology for that is "capital gains". So you aren't paying tax on the whole house, just on the difference between what you bought it for and what you sell it for. If you have made improvements to your home, such as additions or remodels, you can also subtract those from the profits.
There are two tax rates for capital gains: short-term and long-term. If you own something for more than a year, it qualifies for the lower long-term tax rate (20%). That should be the case for your primary residence, so the tax rate is lower than what you had been fearing.
There are also limited exceptions from capital gains for homes. Every two years, you can deduct \$250,000 (single taxpayer), or $500,000 (married taxpayers) from the capital gains on a home sale. That means that majority of American homeowners will never pay a cent of income tax from buying and selling homes to live in.
Here is a concrete example. Bob sold his home for \$700,000. He had bought it 10 years before for \$300,000. He had installed a pool and finished the basement which cost him \$100,000. The total price of his home (the "basis") is \$400,000. His capital gains are \$300,000. Since he is is single, he can deduct \$250,000 from that which leaves him with \$50,000 on which he needs to pay income tax. At the 20% long-term capital gains rate, he will owe $10,000 in income taxes.
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