Written by James Hirby | Fact checked by The Law Dictionary staff
If you're like most homeowners, you might not be aware that the federal capital gains tax could apply to the sale of your home. Unlike regular income tax, capital gains tax is applied to the income that you earn as a result of the sale of a tangible asset like a stock or real estate property. In rare cases, it may be applied to non-liquid assets like art pieces and wine collections.
If you turn a profit on the sale of any residential or commercial property that you own, you must be prepared to pay capital gains tax on it. By contrast, you must be prepared to write off any loss that you take on the sale of such a property. To write off a loss, you'll need to subtract its value from your total taxable income .
However, there may be exceptions to this rule. In certain situations, you may be able to sell a home without paying capital gains tax on the profits. Depending upon the applicable capital gains rate for your income bracket, this could increase the value of the sale's proceeds by as much as 40 percent.
In order to take advantage of this tax loophole,
you'll need to reinvest the proceeds from your home's sale into the purchase of another "qualifying" property. This reinvestment must be made quickly: If you wait longer than 45 days before purchasing a new property, you won't qualify for the tax break. For this reason, you'll need to be ready to close on the new property immediately after selling your old house. Fortunately, many real estate brokers understand that their clients operate under this constraint. If you explain the situation to your broker, he or she is likely to delay your current home's closing date.
To make matters even more complicated, you'll need to involve a third party in the tax-free transaction. This individual or bank is known as the deal's "accommodator." Unfortunately, this person or entity must have no financial interest in the transaction. As such, your real estate broker or mortgage lender may be ineligible to fill the role.
In certain circumstances. you may be able to extend the 45-day deadline for several months. If your accommodator agrees to "identify" the property that you wish to purchase, you'll be permitted to wait for as long as six months to close on it. During this time, you won't have to pay interest charges or taxes on the proceeds from your old home's sale.