Taxes on Selling a House in Illinois
There are a myriad of reasons why you’d consider selling your home and even more reasons why taxes play a major role in how you sell.
For instance, robust demand for real estate has led to the average home sale price tripling in the last 30 years. In all likelihood, a home is the biggest purchase in a person’s lifetime, so maybe you’d like to cash in your gains while we are still in a seller’s market.
Another reason for selling is if you happen to have inherited a property whose value had risen dramatically over the years, but you live out-of-state and have no intention of keeping it.
Or maybe, you and your spouse are retirees whose children have long since moved out so you have decided that moving to a smaller house and spending less on property upkeep is the way to go.
Whatever your reasons for selling, it is highly probable that you’re selling for a substantial gain. And of course, the Internal Revenue Service (IRS), would love a piece of that pie.
Fortunately, there are plenty of strategies to lessen the amount of Illinois taxes you have to pay after a home sale.
By planning carefully, there are even ways that allow you to walk away from the sale of your home absolutely tax free, allowing you to enjoy the profits to the fullest!
What is Capital Gains Tax?
Before we dive into the ways we can minimize the tax impact on a home sale, we must have an understanding of what capital gains tax is.
Capital gains tax is a percentage of the profit realized from the sale of a capital asset such as real estate, machinery, or stocks and bonds. To get the capital gains, the cost basis (consisting of the original purchase price and any expenses incurred during ownership of the asset) is subtracted from the Illinois selling price.
For example, you bought a townhouse ten years ago for $80,000. The property has appreciated and it now has a market value of $150,000, which you also set as your selling price. Additionally, you did home improvements such as a recent kitchen remodeling and changing the brick veneers in the façade for $20,000.
Your cost basis is thus raised to $100,000.
Capital gains = Selling price – Cost basis
Capital gains = $150,000 – $100,000
Of course, you will still be able to deduct the closing costs, settlement fees, and other costs associated with the sale, but for simplicity’s sake, the taxable income from the sale is $50,000.
Do You Have to Pay Capital Gains Tax when You Sell Your House?
The capital gains taxes you need to pay depends on three factors: a) appreciation in your property’s value; b) income tax bracket; and c) homeownership tenure.
Homeownership tenure, or the length of time you owned the Illinois property, is important because it determines whether the profit or gain you may have is classified as short term capital gains or long term capital gains. Additionally, tax rates vary which depends on your filing status.
Short Term Capital Gains Tax
If you owned a property for 1 year or less prior to the sale, whatever profit you have made is classified as a short term capital gain. Your tax bill will depend on your income tax bracket and Illinois tax filing status, sometimes amounting to 37% if you’re a high-income earner.
Long Term Capital Gains Tax
If you owned the property for more than a year prior to the sale, the profit is considered a long term capital gain, and the appropriate capital gains tax rates will apply.
A long term capital gain gets preferential tax treatment compared to short term, and the vast majority of taxpayers will pay no more than 15% in this case.
However, for high-income earners (annual income above $501,600), a capital gains tax rate of 20% will apply. On the opposite end of the spectrum, low-income earners (annual income below $80,800) don’t have to pay capital gains taxes.
Is There a Way to Avoid Capital Gains Taxes?
Yes, there is a way to avoid capital gains taxes!
This is largely thanks to the Taxpayer Relief Act of 1997. Depending on your circumstances, it is now possible to walk away from a Illinois property sale without paying a single cent in taxes on whatever you gain from the sale.
Before the Act went into effect, you had to use the proceeds from the home sale to buy another, more expensive property within two years. Otherwise, you wouldn’t be able to avoid capital gains tax.
How Do You Qualify for Capital Gains Tax Exemption?
It is possible to obtain a tax shield of up to $250,000 when filing as a single individual, or up to $500,000 when married and filing a joint return with your spouse. This is due to the homeowner exclusion which can be found in Section 121 of the tax code.
To get the maximum exclusion of gain, you must fulfill the following requirements:
You must own the Illinois home for two years prior to the sale. If you’re married and filing jointly, only one of you needs to meet this requirement to be able to unlock the tax break.
To claim the tax break, the property you are selling must be considered your primary Illinois residence. This means that you must live in the home for at least two years in the last five years of owning it. The two years doesn’t need to be continuous.
The residence requirement is also known as the 2-out-of-5-year rule in real estate.
If you haven’t claimed the tax break for less than two years prior to the home sale, you are eligible to claim this capital gains exclusion.
Is There an Exception to the 2 out of 5 Year Rule?
Even if you did not fulfill the primary Illinois residency requirement, you may be able to qualify for maximum exclusion of capital gains if any of the following applies to you:
- You or your spouse is in the military, peace corps, or police force during the time you owned the home
- You converted your primary residence, or a portion of it, into a commercial or rental property
- You purchased the home, and are selling it in a 1031 exchange.
Is There a Partial Exclusion of Gain?
There is still a way to protect some of your profits in case you are selling the property after owning and living in it for less than a year.
For example, even if you only lived in your Illinois home for six months before you have to move, you can claim a 25% tax shield. This means, depending on your filing status, up to $125,000 of your profits is protected. Short term capital gains tax rate will apply in this case.
If you lived there for more than a year, a higher tax shield percentage (subject to long term capital gains tax rates) will apply.
Illustration: Capital Gains Tax on the Sale of Your Home
To further understand how capital gains taxes work, let’s say you have a property in Fort Myers, Florida acquired last 2010 for $400,000. This also serves as your primary Illinois residence, having lived here for the past eight years.
Fort Myers experienced a whopping 46% increase in real estate prices over the last year alone, so, wanting to cash in on your investment, you are selling it for $1.2 million now. The projected capital gains from the sale is $800,000.
Projected capital gains = $1,200,000 – $400,000
Projected capital gains = $800,000
As married people filing jointly, you will be able to exclude $500,000 if you fulfilled the ownership, residence, and lookback requirements, leaving you with $300,000 in taxable gain. Your combined income places you in the top bracket, and therefore a capital gains tax rate of 20% is due.
Taxable capital gains = Projected capital gains – capital gain exclusion
Taxable capital gains = $800,000 – $500,000
Taxable capital gains = $300,000
Tax due = taxable capital gains * tax rate
Tax due = $300,000*20%
Therefore, you must pay taxes amounting to $60,000.
What are Other Taxes on Sale of a Home?
In addition to the capital gains tax, you may still owe taxes in the form of Illinois real estate transfer taxes and property taxes.
Real Estate Transfer Taxes
A real estate transfer tax is a one-time tax payment paid after the sale of a property. It is an ad valorem tax, meaning “according to value”, and varies depending on the jurisdiction.
Property taxes, on the other hand, are recurring taxes that are calculated as a percentage of the fair market value. Similar to Illinois real estate transfer taxes, they are also an ad valorem tax, and depend on where the real property is located.
For instance, people who live in Hawaii only need to pay 0.3% of their home value in taxes annually, in contrast with those in New Jersey, who owe taxes amounting to 2.21% of their home value.
Do You Have to Pay Taxes when Selling a Second Home?
Based on the eligibility requirements for maximum exclusion of capital gains, you are only able to claim the tax break of up to $500,000 when selling your Illinois primary residence. Therefore, if you’re selling your second home in the same tax year as the other property (your erstwhile primary residence), then you’re liable to pay taxes on the former.
To avoid paying taxes, you can either live in the second home for two years before selling (the 2-out-of-5-year rule), or do a 1031 exchange on this property (read more below).
Is There a Way to Minimize Taxes when You Sell Your Home?
Yes, minimizing taxes when selling your Illinois home is common, and we will go over 8 ways to achieve this.
Convert the Property into Your Principal Residence
To qualify for homeowner exemption from capital gains tax on Illinois real estate, you must live in the property for at least two years.
If you’re a budding house flipper, you can consider doing a live-in flip, wherein you renovate your principal residence before selling for a profit. If you’re married filing jointly with your spouse, you get to claim the $500,000 tax shield!
You could do this every two years, and as long as your profits don’t exceed the exclusion threshold, you could practically sell it tax free so you get all the profits!
Convert Your Home into a Rental Property
What if even with the exclusions, your property has appreciated dramatically that you will still owe capital gains taxes when you sell?
Well, you can convert it into a Illinois rental property so you have a steady cash flow for the years to come. If you don’t sell it, you don’t ever need to pay the capital gains tax on real estate.
Investing in an Opportunity Zone
In 2017, Opportunity Zones were created to encourage individuals to invest in economically disadvantaged areas to create jobs and spur growth in exchange for tax benefits.
If you sell a property and choose to invest the proceeds in an opportunity zone, the capital gains taxes will be deferred. After five years, you’ll get a step up of 10% in your cost basis. After seven years, you get 15% step up in your deferred gain. Ultimately, after ten years, you can choose to cash out your Illinois investment property and you wouldn’t owe tax on it.
Do a Like-Kind/1031 Exchange on Investment Property
When doing a like-kind or 1031 exchange, the Internal Revenue Service (IRS) allows you to avoid paying taxes on capital gains indefinitely as long as you fulfill the following conditions:
- The real estate to be acquired is an investment property
- The proceeds from the home sale will be used to purchase a replacement property of equal or higher value
- After closing on the sale of the previous property, the replacement property will be identified in 45 days or less
- After closing on the sale of the previous property, the purchase of the replacement property will be closed in 180 days or less
A like-kind exchange gives you the opportunity to keep growing your real estate portfolio without ever paying capital gains taxes.
If you’d like to start being a real estate investor, this is the way to go. For example, you save part of your gross income to be able to afford the down payment on a rental property worth $100,000.
It is possible that the cash flow from the Illinois rent will be enough to cover the mortgage amortization so you just continuously build equity as the property appreciates. After a few years, you sell the rental, and by using a 1031 exchange, you avoid capital gains taxes.
You instead put the proceeds on the purchase of another, bigger multifamily rental for $200,000.
Keep doing this for a few years, buying and selling more investment property until the cash flow from the rentals allows you to retire comfortably without ever paying a cent in capital gains tax.
For real estate investors, they are able to offset capital gains from selling an investment property if they realize a capital loss on another capital asset that they are selling in the same tax year. This practice is called tax-loss harvesting, and is routinely deployed by investors for underperforming assets–not just real estate!
To illustrate this, say an investor took a loss of $15,000 from selling some stocks after a market correction. The investor then sells a Illinois rental property for a taxable gain of $25,000 in the same year. Subtracting the loss, they only need to pay capital gains taxes on the remaining $10,000, instead of the $25,000.
Because of the offset, not only is the investor able to cut their losses in a bear market, they also pocket a larger part of the profit from the home sale that would allow them to reinvest the money and recover sooner.
Raise Your Cost Basis by Home Improvements
The amount of capital gains taxes you need to pay after the sale of your Illinois home is dependent on cost basis. This is the total amount you paid for a capital asset–the purchase price, and yes, this includes the renovation costs. One thing to take note of: maintenance expenses typically do not increase the cost basis since they merely keep the property in good working condition, and does not necessarily add value.
In order to raise your cost basis, you must diligently and religiously keep track of all the receipts, invoices, credit card bills, and contracts related to the renovations so you’d be able to lower your tax bill when it’s time to sell.
Pro tip: Take photos of all the renovation and home improvement documents and save them in a folder or in the cloud so you’d be able to easily get them when the time comes. Who knows, by raising the cost basis you might not have to pay taxes at all!
Partial Capital Gains Exemption
To reduce the tax you need to pay, you can check the Internal Revenue Service (IRS) guidelines to see if you qualify for financial protection on capital gains taxes. Just remember to consult a tax professional to find out how much exemption you can claim before you sell your house.
These exemptions can be granted if you need to sell your Illinois home because of:
You are qualified for a partial exemption if you, your spouse, or your co-homeowner is forced to move to a new job location that is at least 50 miles away from your primary residence, necessitating the sale of your home. Although you have a choice whether to convert it into a rental or sell the home.
Even if you lived in your Illinois primary residence for less than a year prior to selling, the IRS is considerate enough to grant an exemption if its for a health-related reason.
For example, the treatment that you need can be found in another state or country, therefore you need to sell your house to be able to move. Or, it could also be that you or a family member is prescribed by your doctor to move to a different climate to improve your health.
There are plenty of unforeseeable events that are grounds for capital gains tax exemption. Among others include:
- Your home was destroyed due to natural disasters such as floods, earthquakes, hurricanes, storms, sinkholes, and so on
- Your home was condemned or destroyed by man-made disasters or an act of terrorism
- Unforeseen life events such as a divorce, a death in the family, or loss of a job that would drastically reduce your household income and render you incapable of paying your living expenses and real estate taxes, and thus, make you eligible for unemployment compensation
- Other events that may be deemed unforeseeable by the IRS
Consider Installment Sales to Lower Taxes
If you can afford to wait, you may be able to realize a larger profit.
You can explore the option of an installment sale, which is a form of seller financing. In this case, the buyer makes a down payment, with the balance paid over a regularly, agreed-upon number of years. You and the Illinois buyer can negotiate on the interest rate.
When filing your tax return, you will be using the installment method provided by the IRS. Under the installment method, the buyer’s payments will be divided into three classes for tax purposes:
- Gain from the sale
- Return of your cost basis on the property
The gain from the sale will be taxed using long term capital gains tax rates. On the other hand, the interest will be treated as part of your ordinary income, and thus will be taxed depending on your Illinois bracket. The cost basis is a tax free amount.
Closing Thoughts: Taxes on Selling a House Illinois
Dealing with real estate and taxes in Illinois can be daunting.
The IRS would love to slap some capital gains taxes on your home sale and it can make a significant dent in your profits. Fortunately, there are a lot of strategies to avoid this, and exemptions you may be qualified to claim as long as you fit certain criteria.
That said, it is worthwhile to meet with a tax professional who may have valuable insights in this area of finance specific to where you’re located.
If you are ready to sell your property, we’re more than happy to help you here at Sell My House Fast! Similar to working with a local tax professional, sellers typically receive more accurate offers when working with a local investor specializing in their unique market, and Sell My House Fast provides exactly that!
Just fill out our form below to get a free cash offer from a local real estate investor in your market!
If you’d like to get in touch with us first, just call us at (844) 207-0788 and we’d be glad to answer any questions that you may have.
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Taxes on Selling a House Illinois
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Author: Andy Kolodgie
Andy Kolodgie is an experienced real estate investor with a network that expands nationwide. As owner of Sell My House Fast, Andy’s goal is to provide home sellers with more options to their real estate problems than a traditional home sale. He’s been featured on multiple publications including Yahoo Finance, MSN, HomeLight, Credit.com, Apartment Therapy, Business.com, LegalZoom, Zolo, and Creditcards.com.