3 Real Estate FAQs for Buyers, Sellers, and Investors
Money Girl answers 3 FAQs about real estate to help you succeed whether you’re a buyer, seller, or investor—or even if you just plan to become one someday.
It’s summertime, a busy season for real estate sales. That’s probably why I recently received several questions about buying and selling homes.
In this episode, I’ll answer 3 questions that will help whether you’re a real estate buyer, seller, or investor, or plan to be one someday. I’ll also include many resources to help you learn more.
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How to Sell Your Home Tax Free
Real Estate Question #1: An anonymous Money Girl reader asks, “I understand that a married couple can sell their home tax free if they have a capital gain of up to $500,000. Does that benefit apply to every home you sell or is it just a one-time exclusion?”
Answer: First, I want to clarify what a capital gain is exactly. You probably know that you have to pay ordinary income tax when you make money from a job, business, or bank savings account.
Well, you also have to pay tax on profit that you make from an investment or the sale of a capital asset, such as real estate, stocks, mutual funds, and many other types of investments.
If you sell an investment or home for a profit, you have a capital gain. And if you lose money on the sale of a capital asset, you have a capital loss.
Fortunately, there is a gift in the federal tax code that allows you to skip paying some or all of the capital gain tax when you sell a home. The good news is that this jewel of a tax break applies to every home you sell for your entire lifetime—as long as you comply with the rules, which I’ll cover in a moment.
But the IRS wasn’t always so generous. The home sale capital gains exclusion used to only apply if you bought a more expensive home within two years. You were also only allowed a once-in-a-lifetime exclusion of up to $125,000 if you were age 55 or older.
Now, the rules are much more favorable because no matter your age, you can sell your home, pay no tax on some or all of the gain, and do anything you want with the profit. The capital gains tax exclusion tops the list as one of the best tax breaks for Americans.
The capital gains tax exclusion tops the list as one of the best tax breaks for Americans.
Let’s say you purchased your home for $200,000 in 2010. Now, due to market appreciation, you’re able to sell it this year for $300,000 after all closing costs and expenses. For the sake of this example, assume your purchase price and your cost basis for tax purposes are the same, which would give you a capital gain of $100,000.
How to Avoid Capital Gains Tax on Real Estate
Ordinarily, as I previously mentioned, when you sell an asset for a profit, you owe tax on all of the gain. However, if you follow these 5 rules you can avoid some or all of the capital gains tax on real estate sales:
Rule #1: You must pass an ownership and use test
You must have owned and lived in your home for at least two out of the five years prior to a home sale. For instance, you could live in a home for two years, rent it out for three years, and then sell it and take the gains exclusion. Theoretically, you could reap a tax-free gain every two years if you were willing to sell, buy, and relocate that often.
As long as you can claim residency for any two of the previous five years before you sell a home, you’re eligible for the gains tax exclusion. There are even some legal exceptions if you have to sell before two years, including having to move for a new job, divorce, heath reasons, military service, or unforeseen circumstances.
Rule #2: There is an exclusion limit
You can exclude up to $250,000 of a home sale gain or up to $500,000 if you’re married and file a joint tax return. Again, these limits apply to every home you sell, with no limit during your lifetime.
Rule #3: Exclusions apply only to main homes
If you own more than one home, you can exclude the gain on the sale of your main residence only. Your main home is the one you live in most of the year.
Rule #4: Gains above the exclusion are taxable
Any gain you make that exceeds the exclusion amount is taxable and must be reported on Form 1040, Schedule Dopens PDF file , Capital Gains and Losses.
Rule #5: Home losses are not deductible
If you sell your main home for a loss, it cannot be deducted from your taxable income.
For complete information, refer to IRS Publication 523opens PDF file , Selling Your Home. It includes worksheets to help you figure the amount of gain you’re eligible to exclude from tax. If you’re still unclear about your situation, be sure to consult with a tax professional.
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Mistakes First-Time Homebuyers Should Avoid
Real Estate Question #2: Tom T. asks, “I want to start gathering information about buying a house. Do you have any real estate advice or podcast episodes geared toward millennials?”
Answer: I’ve written many articles and done several podcasts to help first-time buyers successfully navigate a real estate purchase. Here are some shows I recommend:
- What Every First-Time Home Buyer Should Know
- How to Buy a Home in 10 Steps, Part 1
- How to Buy a Home in 10 Steps, Part 2
Since there’s a lot to know about buying a home, I’m going to cover three common mistakes that first-time homebuyers should avoid:
Mistake #1: Shopping for a home before getting pre-qualified for a mortgage
Not only does getting pre-approved for a home loan tell you exactly how much home you can afford, it comes with other benefits. Being pre-qualified for a mortgage tells your real estate agent that you’re a serious homebuyer. In fact, most good agents won’t even work with you until you’re pre-approved.
Pre-approval saves you and the agent a lot of time because you can focus on homes that are in your price range only. That helps avoid the heartache of falling in love with something you can’t afford.
Another huge benefit of getting pre-qualified for a home loan comes when you make a purchase offer. The seller will know that you have the means to buy their property and can close the sale quickly.
Depending on the seller’s circumstances, being able to close quickly could give you a huge leg up. They may accept your offer instead of a higher one that would take longer to close.
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Mistake #2: Ignoring first-time homebuyer programs
There are many great programs for first-time homebuyers that may include mortgage interest subsidies or down payment assistance. But did you know that even if you owned a home in the past, you may still be eligible?
Many first-time homebuyer programs define a first-timer as someone who has not owned real estate in the past 3 years. So be sure to investigate and ask your mortgage lender how these programs could save you money, even if you owned a home in the past.
See also: Do I Qualify for an FHA Home Mortgage Loan?
Mistake #3: Considering only a 30-year fixed-rate loan
While it’s true that 30-year loans are still the cornerstone of mortgages, they may not always be the best choice for first-time homebuyers.
If you believe that your family will grow or that you’ll earn more in a few years and may want to buy a larger home, consider getting an adjustable-rate mortgage (ARM) instead of a fixed-rate mortgage.
With an ARM you get a lower introductory rate and lower monthly payments, which can save you money in the short term. Having lower monthly payments may allow you to qualify for a larger loan and buy more home than you could get with a conventional 30-year fixed-rate loan.
See also: 7 Things to Know About Adjustable-Rate Mortgages (ARMs)
If you’re ready to find a lender and get pre-approved for a mortgage, I created a one-page reference guide called the Online Loan Comparison Chart. This resource spells out each lender’s starting APR, their maximum loan amounts, and the type of loan they offer, such as home loans, auto loans, business loans, or personal loans. Click here to download the free Online Loan Comparison Chart PDF.
Should I Sell My Home to Buy Investments?
Real Estate Question #3: Anthony F. asks, “I live in a great neighborhood and want to purchase rental properties here, but don’t have the cash for down payments. If I sell my house, I could raise about $125,000 to buy properties, and then move into a rental. Should I do this in order to buy more real estate and stock investments?”
Answer: Having a nice chunk of equity in your home is a great position to be in. While it’s really tempting to sell your home and use the equity for investments, I’m going to recommend that you don’t.
Since you mentioned that you’re considering renting your next home, I’d keep your current house and turn it into a rental instead of selling it and buying a different rental property.
Here are three major advantages to keeping your home and turning it into an investment instead of financing the purchase of a different rental property:
Advantage #1: Keeping an owner-occupied mortgage
When you finance a rental property, the interest rate will be relatively high because it’s for a non-owner occupied property. Keeping your current loan in place could help you have good cash flow.
Advantage #2: Familiarity with the property
Since you live in the home you know its good and bad points and the neighborhood like the back of your hand. Buying a property always comes with uncertainty about its history or some hidden damage that an inspector could miss and you or a tenant discovers later on.
See also: Should You Pay Down Debt or Invest?
Advantage #3: Convenience
It’s just plain easy to stick a “For Rent” sign in the yard and run ads to see if you can charge a rent that makes it profitable to turn your home into a rental.
If you can make the property cash flow and move into a rental that cuts your expenses, you’ll be saving money and earning extra income at the same time. This arrangement could be the ticket for saving or building investments in a brokerage account that you could use to buy more real estate down the road.
However, before you move a tenant into your home, just be sure that your mortgage lender won’t penalize you for turning your residence into an investment property. Some mortgages may charge you a penalty or require you to refinance into a more expensive, non-owner occupied loan. Or they may require a one- or two-year waiting period before you can rent out the property.
Once you switch your insurance from a homeowner’s policy to a less expensive landlord policy, the lender will definitely know that you’re not living there anymore. So read your mortgage or call the lender to make sure that you understand what’s allowed.
See also: How to Rent Your House and Buy Another One
As always, it’s a smart idea to consult a tax or financial advisor when making important decisions such as selling your home.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
