Capital Gains Tax in Real Estate: What Homeowners Need to Know Before Selling

If you’ve owned your home for a while and it’s gained significant value, selling can trigger something most people don’t think about until it’s too late: capital gains tax.

The good news? There are some major exemptions, especially for homeowners who have lived in their property for years. And if you’re older and ready to downsize, there are smart strategies (including Prop 19) to ease the financial impact.

Let’s break it down—with real-world examples.

What is Capital Gains Tax?

Capital gains tax is what you owe on the profit from selling a property. It’s calculated as:

Sale Price - Purchase Price - Deductible Costs = Capital Gain

Then you’re taxed on the gain—not the full sale price.

Primary Residence Exemption: The $250K/$500K Rule

If the home you're selling is your primary residence, and you've lived in it for 2 out of the last 5 years, the IRS lets you exclude:

• $250,000 in gain if you’re single

• $500,000 if you’re married and filing jointly

Example 1: Karen’s Long-Time Family Home

• Bought in 1994 for $400,000

• Sells in 2025 for $1,100,000

• She’s single and lived there for the past 10 years

Her gain: $700,000
Exemption: $250,000
Taxable gain: $450,000

She’d only be taxed on the $450,000 after the exemption—but hang tight, there’s more she can do to reduce that number.

What Can You Deduct From the Gain?

To lower your capital gains, you can subtract qualified expenses, such as:

• Major improvements (remodeled kitchen, new roof, room additions—not basic maintenance)

• Closing costs when you bought and sold the property

• Selling expenses, including real estate commissions, staging, advertising, and escrow fees

Example 2: Karen Continued

• Remodeling + improvements: $75,000

• Commission & selling costs: $55,000
  New taxable gain: $320,000

This shows how planning ahead—and working with a realtor who understands these deductions—can save you tens of thousands in taxes.

What if You’re Older and Ready to Sell With a Ton of Equity?

For many older homeowners sitting on decades of appreciation, even with the $500K exemption (if married), the taxable gains can still be significant.

There’s no Prop-19-style capital gains relief, but there are smart moves to explore:

1. Tax-Deferred 1031 Exchange (for investment properties only)

You sell one investment property and roll the proceeds into another to defer the capital gains.

2. Move-In Strategy

If you’re selling a former rental or vacation home, you could move in and make it your primary residence for 2 years to qualify for the $250K/$500K exemption.

3. Installment Sale

Spread the gains over time (if the buyer agrees to pay in installments), so you’re not hit with one massive tax bill.

4. Estate Planning

If you plan to pass the property to heirs, they’ll typically receive a “step-up in basis” to current market value—meaning they won’t pay taxes on your gains. This is a huge advantage of holding vs. selling during your lifetime.

Combining Capital Gains Planning with Prop 19

If you're 55+ and ready to move, Prop 19 lets you keep your low property tax base when buying a new home in California—but it doesn't protect you from capital gains.

That said, it pairs well with capital gains planning because:

• You’re more likely to actually sell and move (which many older homeowners delay out of fear of a tax hike)

• You can downsize or relocate strategically, then use the capital gains exemption to reduce your tax bill

Key Takeaways

• If you’ve lived in your home 2 out of the past 5 years, the IRS lets you exclude $250K–$500K in gains.

• You can also deduct improvements, closing costs, and selling fees.

• Prop 19 helps with property taxes, not capital gains—but using both strategies together can save you significantly.

• Investors and older homeowners should explore installment sales, 1031 exchanges, or estate plans to reduce or defer taxes.

Thinking of Selling? Let’s Strategize It Right

Whether you’re planning a move, inheritance, or investment sale, I can help you crunch the numbers and connect with the right professionals to make it smooth and tax-smart.

Please consult a CPA before making any decisions.