About Capital Gains

If you are selling a home you have owned for less than two years, or if you have not used it as your primary residence for at least two of the last five years, capital gains tax is something you should be aware of before you close. It does not apply to every seller, but if it applies to you, the financial impact can be significant.

Important: This is general information to help you understand the topic. It is not legal or tax advice. Every situation is different, and you should consult a qualified tax professional or CPA for guidance specific to your circumstances.

What Are Capital Gains?

Capital gains are the profit you make when you sell an asset for more than you paid for it. In real estate, that means the difference between your purchase price (plus qualifying improvements and selling costs) and your sale price. If you bought a home for $300,000 and sell it for $400,000, you have a capital gain of roughly $100,000, minus eligible deductions.

The IRS 2-of-5-Year Rule

The IRS offers a significant exclusion on capital gains from the sale of your primary residence — up to $250,000 for single filers and $500,000 for married couples filing jointly. But to qualify, you must have owned the home and used it as your primary residence for at least two of the five years before the sale.

The two years do not need to be consecutive. If you lived in the home for 2019 and 2021, for example, that would qualify. But if you have owned the home for less than two years total, or if it was an investment property or second home for most of that time, you likely will not qualify for the full exclusion.

Short-Term vs. Long-Term Rates

How long you have owned the property also affects the tax rate on any gains that are not excluded:

• Short-term capital gains (owned less than one year) — taxed as ordinary income, which means your regular income tax rate applies. Depending on your tax bracket, this could be 22%, 32%, or higher.
• Long-term capital gains (owned one year or more) — taxed at preferential rates, typically 0%, 15%, or 20% depending on your income level. This is a meaningful difference.

Texas and State Income Tax

One piece of good news if you are selling in Texas: there is no state income tax. That means capital gains are only subject to federal tax. In states with income tax, sellers can face both federal and state capital gains taxes, so this is a genuine advantage of selling in Texas.

Partial Exclusions

Even if you do not meet the full 2-of-5-year requirement, you may qualify for a partial exclusion if the sale is due to certain circumstances, such as:

• A job relocation (typically 50+ miles)
• Health-related reasons
• Certain unforeseen circumstances (divorce, natural disaster, etc.)

The partial exclusion is calculated based on the percentage of the two-year requirement you met. For example, if you lived in the home for one year (50% of the requirement), you may be able to exclude 50% of the maximum amount.

The Takeaway

If you have owned and lived in your home for at least two of the last five years, you are likely in good shape — the exclusion amounts are generous. If you have not, it is worth talking to a tax professional before you sell so you know exactly what to expect and can plan accordingly. This is not something you want to discover after closing.