The answer to this question depends on several factors, including the profit you make on the sale of your home, the state in which you live, and any applicable tax laws.
Is It a Residential Property or Investment?
The first step is to determine whether your home is considered a residential property or an investment. If you live in the property and sell it, it is considered a residential sale. However, if you own the property and do not live in it, it is considered an investment sale.
What’s the difference? It matters because the IRS taxes investment sales at a higher rate than residential sales. When you sell a residence, you get a reduction in the amount that you’re taxed. You don’t get that deduction with an investment property.
How Much Profit Will You Make?
The next step is to determine how much profit you will make on the sale of your home. For example, if you sell your home for $200,000 and you paid $100,000 for it, you will have a $100,000 profit. But a certain amount of profit is “free” (untaxed) if you’re selling your primary home. This amount changes from year to year, but it’s substantial. Most people won’t be taxed on any profit they made from selling their residential property.
For an investment property (or any property you did not live in), the entire amount may be taxed as either short-term or short-term capital gains.
If you inherited a property, note that your cost basis is the value it was inherited at. So, if you inherit a $500,000 property and later sell it for $600,000, you will pay taxes on the $100,000 difference, not the full $600,000 amount.
Property Taxes on Sold Houses
The third factor to consider is whether you will owe any property taxes on the sale of your home. This answer depends on the state in which you live. Some states have what’s called a transfer tax, which is a tax on the sale of real estate. The amount of this tax varies from state to state, but it’s usually a percentage of the sale.
If you currently owe property taxes, you will have to pay them upon close. But if you have already paid your property taxes for the year, you will not be required to pay them again.
How Do You Pay Taxes When Selling a House?
At the closing of the sale, the buyer will usually write you a check for the purchase price of the home. If you owe any property taxes, the escrow company will take this out of the amount before they give it to you. Once you’re in possession of the funds, you are responsible for any other taxes that you will owe.
Consequently, you should make sure that you set aside enough money to pay your taxes. Otherwise, you could end up in a difficult situation at the end of the year. Don’t assume that just because taxes weren’t taken out of your check that they aren’t owed.
The Bottom Line
When selling your home, it’s important to understand the tax implications. The amount of taxes you will owe depends on several factors, including whether your home is considered a residential or investment property, how much profit you make on the sale, and whether you will owe any property taxes.
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