What does "Capital gain" mean in real estate?
Capital gain in real estate is the profit realized when you sell a property for more than your adjusted basis (original purchase price plus qualifying improvements and certain expenses). In short: Capital gain = Selling price − Adjusted basis.
Core concept
- Adjusted basis: purchase price plus capital improvements (e.g., adding a deck, remodeling) and certain acquisition costs; routine maintenance and repairs do not increase basis.
- Realization rule: capital gains are taxed only when the gain is realized — that is, at the time of sale, not while you hold the property.
- Holding period and tax rates:
- Short-term capital gains: asset held one year or less — taxed at ordinary income rates.
- Long-term capital gains: asset held more than one year — taxed at preferential rates (0%, 15%, or 20% depending on taxable income).
Primary residence exclusion
Homeowners who meet the ownership and use tests may exclude some or all of the gain from tax:
- Up to $250,000 for single filers or $500,000 for married filing jointly.
- Eligibility: owned and lived in the home for at least 2 of the last 5 years before sale and not having used the exclusion in the prior 2 years.
- The exclusion can be prorated or reduced for certain unforeseen circumstances (job relocation, health issues, divorce, etc.).
Real-world examples
- No gain after improvements: Purchase $150,000 + kitchen renovation $50,000 → adjusted basis $200,000. Sold for $200,000 → no capital gain, no capital gains tax.
- Primary residence exclusion: Bought for $200,000, sold for $800,000 → gain $600,000. Married filing jointly excludes $500,000 → taxable gain $100,000 subject to long-term capital gains tax.
- Investment property: Bought $250,000, sold $400,000 → capital gain $150,000 fully taxable (no primary residence exclusion applies).
Additional considerations
- Selling expenses (broker commissions, legal fees, closing costs) reduce the net amount realized and therefore lower the taxable gain.
- Improvements vs. maintenance: Only capital improvements that increase value or extend useful life add to basis; routine repairs do not.
- Tax planning strategies: hold more than one year to access long-term rates, use the primary residence exclusion when eligible, or consider tax-deferral options for investment properties such as a 1031 exchange.
Understanding adjusted basis, the holding period, selling costs, and the residence exclusion is crucial for estimating and minimizing capital gains tax when selling real estate.
