How to Prevent Capital Gains Taxes When Selling a House

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The capital gain on a house sale is the excess of cash proceeds over your basis, which is the home purchase price plus the cost of any improvements. When you're buying and selling houses for five, six or seven figures, capital gains taxes can be enormous. However, if you have some foresight, you can take steps to reduce the taxes or even exclude the gain completely.

Make it Your Primary Residence

The IRS allows taxpayers to exclude up to $250,000 of capital gains when selling their primary residence. If you're married, you can exclude up to $500,000. For a house to qualify as your primary residence, you must have owned and lived in it for two of the last five years prior to selling it. You also can't have acquired the home through a like-kind exchange, and you can't claim the exclusion more than once every two years.

Make Improvements

Home improvements -- like installing a swimming pool, upgrading to central air or adding on a new bedroom -- increase your basis in a home. Since capital gains are the difference between the sales price and your basis, that means that home improvements decrease your capital gains dollar-for-dollar.

To qualify as an improvement, the expense must prolong the home's useful life, substantially increase its market value, repair structural damage or adapt the use of the home. All improvements that you've made since you purchased the home can increase your basis.

Own it For Least a Year

You'll pay more in taxes if you have a short-term capital gain from the house compared to a long-term capital gain. Short-term capital gains, which occur when you own the property for less than a year, are taxed at ordinary income tax rates. In contrast, long-term capital gains are taxed at more favorable rates. For example, a taxpayer in the 33 percent bracket would pay 33 percent on a short-term gain but only 15 percent on a long-term capital gain.

Wait Until You're in a Lower Tax Bracket

The U.S. has a graduated income tax bracket, which means you pay a higher tax rate when you earn more income. If you're in the zero or 15 percent ordinary tax bracket, you don't pay any taxes on long-term capital gains. If you know that your income will decrease soon -- for example, if you're about to retire or plan to take time off work to care for a family member -- wait and sell your house in the year that your income is lower.

Take Losses Elsewhere

Your capital gains are decreased by the amount of capital losses you incurred during the year. If you've got property that you know you'll have to take a loss on at some point, this may be the year to finally sell it. Stock that has plummeted in value, collectibles that have gone out of style and unprofitable real estate investments all are possible sources of capital losses.

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