Did you know there is a tax penalty if you sell your home within two years of purchasing it? Many property buyers are unaware of the taxes that must be paid when selling a home. At the final table, this can be a large and unpleasant surprise. So, what exactly are these taxes, and what are the predicted tax penalties? Is it legal to dodge them?

Real Estate Taxes

Buying and selling real estate involves more taxes than most people believe. That's not to say it's not a terrific or very profitable investment. All you have to do is be aware of these taxes and predicted tax penalties and add them to your calculations.

It is crucial to note that taxes and tax rates vary by state and county in America. The tax consequences will also be determined by your specific position and transactions. Always seek personalized guidance on projected tax penalties from your own tax accountant.

As a house buyer, you will frequently be required to pay real estate "excise" taxes as part of your closing fees. These are determined by the purchase price of the property. If you use a mortgage loan to finance your home, you will also be subject to an "intangible tax" on the amount funded. There could also be a "tax service fee" for taking your money and delivering it to the tax collector.

You will receive an annual property tax bill as long as you hold the property. You may be required to pay income taxes on any rent or other revenues earned during your ownership.

When you sell a house, you will also have to pay documentary stamps on the deed. This is determined by the buying price. Some of these fees are intended to benefit the community. That does not imply that they are always used correctly. In Florida, the proceeds from doc stamps are meant to go into a fund to help affordable housing. In recent years, the state has used millions of dollars from that fund to offset other budget gaps. All while home values skyrocket. States such as New York can levy additional transfer taxes, such as a "mansion tax" on homes worth $1 million or more.

Capital Gains Tax

When you sell your home, you will also be subject to another sort of tax. This is the capital gains tax. It has the potential to be significant.

If you resell your personal house within two years of purchasing it, you will be subject to these additional tax penalties. Short-term capital gains are normally taxed in the same manner as income taxes. If you are in a high-income tax band, this can mean giving up over 40% of your profit. You will have to pay capital gains tax on any second residences and investment properties you sell unless you use creative tax vehicles and exclusions. Long-term capital gains taxation is likewise progressive. 

How To Avoid Capital Gains Taxes (Legally)

Fortunately, there are legal ways to avoid paying this hefty tax right now.

Keep It

Keep your home for at least two years to qualify for a significant tax break. The first $250,000 in capital gains is tax-free if you have resided in the property for at least two of the last five years. If you file as a married couple, the fee is $500,000. So, if you bought a house for $500,000 and sold it for $1 million after two years and one day, you won't incur any capital gains tax. If the market isn't appealing for sale after two years, you can rent it out for three years and then sell, retaining the large tax savings.

Finance It to A New Buyer

If you don't need all of the money from the sale of your property right away, you can sell it on an installment basis. You can, for example, sell your home as a rent-to-own, lease option, or land contract transaction. You might get a cash down payment now, followed by monthly installments. You can agree that they will pay you back in three years when your tax burden is lower.

1031 Exchange

If you intend to reinvest the money in other investment properties, there is a significant tax reduction if you utilize this home as an investment. Because that is frequently the case, if you do not take advantage of this tax relief, you are significantly overpaying your taxes. A 1031 exchange defers taxes on the amount reinvested in other property. You can even take some money now and reinvest the remainder later if necessary. You can keep reinvesting, rolling over gains, and deferring taxes indefinitely.

How long after selling a home do you have to buy another to avoid a tax penalty?

There is no longer a time limit for buying a new house after selling your old one!

Accounts for Self-Directed Retirement and Investing

Did you know you can invest in real estate with your 401k or IRA? Even if you don't have much in your retirement accounts yet, you can invest through them rather than directly with cash.

When you invest through these accounts, you can defer taxes on your gains until you receive them in retirement. Alternatively, you can invest tax-free in a Roth IRA.

When To Take The Hit

It's not too late to take advantage of the above tax savings. You might still be able to get them. However, there may be situations when you are willing to accept the capital gains tax penalty. This is especially true if your property is expected to deteriorate in the coming years. Getting some money now and paying part of it in taxes may be preferable to losing money. If you're in financial trouble and face losing your home or incurring financial penalties, you shouldn't wait and risk losing everything.

Summary

There is a significant tax penalty for selling your house within two years. The tax penalty might be in the high double digits. There are other legal ways to avoid these taxes.

A Realiff real estate agent can help you save a significant amount of money on Realtor commissions to offset any taxes owed on the sale of your house. They can advise you on the best time to sell, assist you in determining the best mode of sale, and offer a net sheet indicating how much you should expect to earn when selling your house.