Key Takeaways:
➡️ Capital gains tax applies when you profit from selling real estate in the US.
➡️ Long-term gains are taxed at lower rates than short-term gains.
➡️ Foreign buyers are subject to FIRPTA withholding, which requires a portion of sale proceeds to be withheld as a prepayment of capital gains taxes.
➡️ You can defer capital gains tax via a 1031 exchange. By reinvesting the proceeds into a "like-kind" property, investors can defer paying taxes on the gains.
Table of Contents
Selling property in the US can lead to significant profits due to equity gained via property price appreciation, but understanding the tax implications of those gains is essential. Capital gains tax is a key factor that can affect your overall return on investment, and it’s something both domestic and foreign buyers need to navigate carefully.
In this guide, we’ll break down capital gains tax for you—whether you’re selling your primary home or an investment property.
Let’s explore the details that every property seller should know to stay tax-smart and maximize profits.
What is Capital Gains Tax?
Capital gains tax is the tax levied on the profit realized from the sale of a capital asset, such as real estate. The profit, known as the capital gain, is calculated by subtracting the purchase price (or cost basis) from the sale price of the asset.
In the context of real estate, capital gains tax applies when a property appreciates in value and is sold for a higher amount than the original purchase price.
There are two types of capital gains:
- Short-term capital gains: These are gains on assets held for one year or less. Short-term capital gains are taxed at ordinary income tax rates, meaning they are subject to your income tax bracket.
- Long-term capital gains: These apply to assets held for more than one year. Long-term capital gains enjoy lower rates than ordinary income, making them more favorable for investors.
How is Capital Gains Tax Calculated?
To calculate capital gains tax, you first need to determine your capital gain:
Capital Gain = Sale Price − Purchase Price (Cost Basis)
However, the calculation doesn’t end there. You can deduct certain costs, such as improvements made to the property over time, which increases your cost basis and reduces your taxable gain.
Keep in mind that you also need to account for any depreciation claimed if the property was used as a rental or business asset.
Let us understand this calculation with the help of an example:
Imagine you purchased a home for $300,000 and sold it 10 years later for $500,000. Without considering other factors, your gain would be $200,000.
Gain = $500,000 − $300,000 = $200,000
If the home was your primary residence, you may qualify for an exemption of up to $250,000 (or $500,000 for married couples filing jointly) under certain conditions. This exemption could eliminate all or most of your capital gains tax.
Capital Gains Tax Rates
The rate at which capital gains are taxed in the US depends on how long the property was held before being sold and the seller’s taxable income. The IRS distinguishes between short-term and long-term capital gains, each with distinct tax implications.
Short-Term Capital Gains Tax Rates
Tax Guide for Foreigners Buying US Real Estate [2024]
Tax Rates for 2024: These gains are taxed at ordinary income tax rates, which, as of 2024, range from 10% to 37% based on the taxpayer’s income level.
Application: Since short-term gains are taxed at the same rate as regular income, they often result in a higher tax liability for individuals in higher income brackets.
Long-Term Capital Gains Tax Rates
For properties held longer than one year, long-term capital gains are taxed at significantly lower rates:
Tax Rates for 2024:
✅ 0% for taxpayers with taxable income up to $47,025 (for single filers).
✅ 15% for taxpayers with taxable income between $47,026 and $492,300 (for single filers).
✅ 20% for taxpayers with taxable income over $492,300 (for single filers).
Rates may vary for other filing statuses (such as married filing jointly, head of household, etc.).
Advantages: Long-term capital gains are taxed at lower rates than short-term gains, providing a significant tax advantage to investors holding assets for longer periods.
Capital Gains Tax Exemptions for Real Estate
When you sell your primary home, you may not have to pay taxes on all the profit from the sale, thanks to an exemption in the US tax code. This exemption allows homeowners to exclude a certain amount of profit from being taxed:
Primary Residence Exemption
✅ Single filers: Can exclude up to $250,000 of capital gains from the sale.
✅ Married couples filing jointly: Can exclude up to $500,000 of capital gains.
To qualify for this exemption, you need to have owned and lived in the home as your main residence for at least two of the last five years before selling it.
For example, if you sold your primary residence for a gain of $200,000, you could exclude the entire amount if you’re single. If you’re married and made $500,000, you would also avoid paying any capital gains tax.
Capital Gains Tax for Foreign Buyers
Foreign nationals who invest in US real estate face different rules. The Foreign Investment in Real Property Tax Act (FIRPTA) requires withholding of 15% of the sale price of the property at the time of sale.
This is not the final liability, but a prepayment of potential taxes owed.
Foreign investors must file a US tax return to calculate their actual capital gains tax and either pay additional taxes or claim a refund if too much was withheld. Tax treaties between the US and other countries can sometimes reduce the amount of tax a foreign seller owes.
Foreign buyers should work with a tax advisor to ensure compliance with FIRPTA and understand their full tax obligations.
Real-Life Scenario: Understanding Capital Gains Tax
Let’s consider a real-life example:
Scenario 1: US Homeowner
John and Lisa bought a home in Florida in 2010 for $300,000. They lived in the house for 12 years and sold it in 2024 for $600,000. Their capital gain is:
Gain = $600,000 − $300,000 = $300,000
Because John and Lisa qualify for the primary residence exemption as a married couple filing jointly, they can exclude up to $500,000 in gains. Since their gain is only $300,000, they do not owe any capital gains tax.
Scenario 2: Foreign Investor
Alex, a Canadian citizen, purchased a vacation home in Miami for $400,000 in 2015. In 2024, he sold it for $550,000, realizing a gain of $150,000. Under FIRPTA, 15% of the sale price, or $82,500, was withheld at the time of sale.
However, when Alex files his US tax return, he will calculate his actual capital gains tax liability. Assuming he qualifies for the long-term capital gains rate of 15%, his tax liability would be:
Tax Liability = $150,000 x 0.15 = $22,500
Since $82,500 was withheld under FIRPTA, Alex would be eligible for a refund of $60,000 after filing his return.
How to Report and Pay Capital Gains Tax
For US taxpayers, capital gains must be reported on Form 8949 and Schedule D of your federal income tax return. Any gains or losses on real estate, whether from a primary residence or investment property, should be included here.
Foreign investors must file US tax returns using the appropriate forms to calculate their final tax liability. They are also advised to work with a US-based tax advisor to ensure all necessary forms are submitted correctly.
One of the most effective strategies for deferring capital gains tax is through a 1031 exchange, also known as a like-kind exchange. Under Section 1031 of the Internal Revenue Code, investors can reinvest the proceeds from the sale of one property into another “like-kind” property, deferring the payment of capital gains taxes.
This allows investors to continue growing their portfolios while preserving more of their profits for future investments.
To learn more about how a 1031 exchange works, including eligibility criteria, timelines, and compliance requirements, check out our comprehensive guide on 1031 Exchange.
The Bottom Line on Capital Gains Tax
Capital gains tax is a crucial consideration for anyone buying or selling property in the US, especially for foreign nationals unfamiliar with American tax policy. Understanding how capital gains are calculated, the available exemptions, and how tax treaties can reduce your liability is essential.
For foreign buyers, working with a knowledgeable tax advisor can help them understand FIRPTA rules and ensure compliance with all US tax laws.
By understanding and planning for capital gains tax, you can maximize your return on investment while staying compliant with IRS regulations.
FAQs
1. How long do I need to live in a house to avoid capital gains tax?
You need to live in the house for at least 2 out of the last 5 years to qualify for the primary residence exemption, which can exclude up to $250,000 (single) or $500,000 (married) from your capital gains.
2. What happens if I sell a property and reinvest in another?
You can use a 1031 Exchange to defer paying capital gains tax if you reinvest the proceeds from the sale into a similar property within 180 days.
3. Do foreigners pay capital gains tax on US real estate?
Yes, foreign nationals must pay capital gains tax on US property sales, and under FIRPTA, 15% of the sale price is withheld at closing. The final tax is determined when filing a US tax return.
4. Can capital gains tax be reduced?
Yes, capital gains tax can be reduced by holding the property for more than one year (qualifying for long-term rates), using deductions like home improvements, or taking advantage of tax credits.
5. Is depreciation recapture taxed when selling a rental property?
Yes, when selling a rental property, you must pay tax on the depreciation recapture, which is taxed at a maximum rate of 25%.
![FIRPTA: What Foreign Real Estate Investors Need to Know About It [2024]](https://homeabroadinc.com/wp-content/uploads/2024/11/FIRPTA-scaled.jpg)
![Tax Guide for Foreigners Buying US Real Estate [2024]](https://homeabroadinc.com/wp-content/uploads/2024/10/TaxesforUSforeignBuyers-1.jpg)
