What Is a Capital Gain?
In real estate, a capital gain is the financial profit you make when you sell a property. The IRS considers real estate to be a "capital asset." When you sell that asset, you must pay taxes on the profit. The amount of the gain is calculated by subtracting your cost basis (what you paid for the property, plus any capital improvements you made) from the final sale price.
Short-Term vs. Long-Term Capital Gains
The IRS taxes real estate profits differently depending on how long you owned the property before selling it:
- Short-Term Capital Gains — If you own the property for one year or less before selling (common in house flipping), the profit is taxed at your ordinary income tax rate. This rate can be as high as 37%, severely cutting into your profits.
- Long-Term Capital Gains — If you own the property for more than one year, the profit is taxed at the much lower long-term capital gains rate, which is typically 15% or 20% depending on your income bracket.
Exemptions and Deferrals
Real estate investors and homeowners utilize specific strategies to avoid paying massive capital gains taxes upon sale:
- Section 121 Exclusion (Primary Residence) — If you have lived in the home as your primary residence for at least two of the five years preceding the sale, the IRS allows you to exclude up to $250,000 of the capital gain from your taxes (or up to $500,000 if you are married filing jointly). You pay zero tax on this excluded amount.
- 1031 Exchange — Commercial and investment property owners can defer paying capital gains taxes entirely by taking the profits from a sale and immediately reinvesting them into a "like-kind" replacement property under Section 1031 of the tax code.
Related Terms
- Capital Improvement — Permanent upgrades that increase your cost basis and lower your tax burden
- 1031 Exchange — The legal mechanism to defer capital gains on investment properties
- Fair Market Value — Drives the final sale price and the resulting gain
Barnes Walker Real Estate Closings
Barnes Walker's attorneys coordinate complex commercial closings and 1031 exchanges to help investors defer capital gains taxes and protect their real estate profits. Submit a title inquiry for assistance.
Reviewed by the attorneys at Barnes Walker, Goethe, Shea & Robinson, PLLC