Published by REALTOR.com | April 14, 2025
The capital gains tax is the tax you owe on that profit when the asset is sold for more than its initial purchase price.
Property owners, including inheritors, have lots of hurdles when it comes to selling a property.
The topic of capital gains tax is a frequent thorn in a seller’s side, but there’s a strategy that can soften the blow.
What is capital gains tax?
Capital gains refer to the profit earned from selling an asset. The capital gains tax is the tax you owe on that profit when the asset is sold for more than its initial purchase price.
“If you buy a property for $300,000 and later sell it for $400,000, that $100,000 gain is potentially subject to capital gains tax,” says Paul Miller, managing partner of Miller & Company Certified Public Accountants.
But there are certain exclusions and exemptions to be aware of, which depend on how long you’ve owned the asset.
Primary residence
The IRS allows every individual, regardless of their income, a tax-free exemption on capital gains from the sale of a primary residence.
“The exclusion is up to $250,000 for single filers and $500,000 for joint filers,” says Miller. This capital gain can be permanently excluded from your taxable income.
However, you do have to meet specific requirements to claim this capital gains exemption:
- The home must be your primary residence.
- You must have owned it for at least two years.
- You must have lived in it for at least two of the past five years.
- You cannot have taken this exclusion in the past two years.
Second home
The IRS treats the sale of a second home differently than a primary home, when it comes to capital gains taxes.
“The primary home tax exclusion does not apply to a sale of a second home, although if you make the second home your primary residence for two years (out of the last five years before the sale), the exclusion can apply to that home as well,” says Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting.
Inherited property
When you inherit property (such as a home), the value of the property is “stepped up” to its market value at the time of the previous owner’s death, according to Luscombe. This means that if you sell the property right after inheriting it, you won’t owe any capital gains tax on any increase in value that occurred before the previous owner’s death.
“However, any gain from appreciation after death is subject to capital gains tax unless also eligible for the exclusion on sale of a principal residence,” says Luscombe.
Investment property
Capital gains tax applies on the sale or exchange of investment property, but Luscombe says the gain on real estate can be deferred by a “like-kind” exchange for other real estate.
So, instead of paying taxes on your capital gain from the sale right away, you “exchange” it for another investment property. This means you don’t pay taxes on the gain until you sell the new property at some point in the future.
This is a tax rule that allows you to defer (or delay) paying capital gains tax on the profit you make from selling investment property, as long as you reinvest that profit into a similar property. The new property must be of a “like kind”—meaning it should be similar in nature or character (for example, you could swap one piece of real estate for another, like exchanging a rental property for a different rental property).
