During the COVID-19 pandemic, interest rates sunk to historic lows while property values soared and housing availability dwindled. Prospective buyers seeking favorable financing terms scrambled to find homes they could afford while interest rates remained low. Unfortunately for many buyers, this meant purchasing a property that did not quite fit their needs. Some bought homes in the country far from high paying jobs — only to be called back to the office once safer-at-home orders lifted. Others purchased properties that were simply too small for their families. Still others waived inspection contingencies, leaving them to pay for costly repairs way beyond their budgets. Whatever the reason, certain homeowners now feel forced to sell their primary residence after less than a year of ownership. In this post, we explore the tax penalties and other financial consequences associated with selling your house after less than a year of ownership. From short term capital gains tax to closing costs, follow below to learn everything you need to know about selling your home shortly after buying.
Terms to Know When Selling Your House After Less Than a Year of Ownership
In order to best understand the financial implications of selling one’s house before a year of ownership, one should be familiar with the following terms:
Short Term Capital Gains Tax
First on our list of terms to know when selling your house is “short term capital gains tax.” In their article “2021-2022 Capital Gains Tax Rates — and How to Calculate Your Bill” for NerdWallet, Tina Orem and Sabrina Parys define the term. Orem and Parys write that “short-term capital gains tax is a tax on profits from the sale of an asset held for one year or less.” Given this, homeowners only pay capital gains taxes once they have sold their property. They only do so if they made a profit on the sale, not if they took a loss.
The tax rate related to short term capital gains “equals your ordinary income tax rate.” Homeowners who wait to sell their homes after at least a year of ownership are not subject to short term capital gains tax. According to the IRS, short term capital gains are reported on Form 1040, Schedule D of your individual tax return.
Long Term Capital Gains Tax
Another tax levied on profits from a home sale, long term capital gains tax is due when a property is sold after more than a year of continuous ownership. In her article “Long-Term vs. Short-Term Capital Gains: What’s the Difference?” for Investopedia, Claire Boyte-White explains. Boyte-White writes that long-term capital gains “are taxed according to graduated thresholds for taxable income at 0%, 15%, or 20%,” with most homeowners paying less than 15%. Capital gains were not always taxed in this manner. For example, the Taxpayer Relief Act of 1997 allowed certain taxpayers to avoid capital gains tax or significantly lower their tax bill when they sell an investment property. It lowered the marginal long-term capital gains rate for investors and offered homeowners an exclusion. We explain this exclusion in further detail below.
Unlike short-term capital gains, long-term capital gains are not taxed like regular income. Taxed like regular income, short-term capital gains could be taxed “up to 37%…depending on your tax bracket.” Because of this, “the tax on a long-term capital gain is almost always lower than if the same asset is sold, and you realize the gain in less than a year.” As such, taxpayers can avoid paying capital gains taxes at a higher rate if they wait to sell their homes. Of course, this is not always possible for the many reasons listed below.
Capital Gains Exclusion or Exemption
As alluded to above, certain homeowners can avoid capital gains taxes altogether. The primary residence capital gains tax exclusion allows homeowners to exclude either $250,000 or $500,000 of the capital gains earned after selling their property. How much you can exclude when you sell your house depends on your tax filing status.
Single tax filers can exclude up to $250k of capital gains and married taxpayers filing jointly can exclude up to $500k of capital gains as long as they have lived in their home for two of the last five years. If a single filer sells his or her home for $225k with a $200k basis, for example, he or she has a tax-free capital gain of $25k. In certain circumstances, homeowners might qualify for a partial exclusion if they do not meet the above requirements.
Partial Exemption or Exclusion
Writing for The Balance in his article “The Capital Gains Tax Exclusion When Selling Your Primary Residence,” William Perez explains. To start, Perez writes that “some taxpayers who sell their residences before meeting the two-out-of-five-years rules might still qualify for a partial exclusion of their gains.” Perez notes that the Internal Revenue Code “allows taxpayers to exclude a portion of their capital gains if they must sell to relocate for work, because of health issues, or due to other unforeseen circumstances” like those detailed below. In order to qualify for a partial exclusion, homeowners must sell because they are required to relocate.
They must still pay capital gains tax if their employer offers a voluntary transfer to another city, and they choose to sell. In order to qualify, homeowners must relocate at least fifty miles from their original property. Homeowners can also qualify for a partial exclusion if they lived in their home “50% of the required time if…in residence for one year” for a capital gains tax exclusion up to $125k. Active members of the military who are called away might also qualify for a partial exclusion. For further clarity, discuss with a certified tax professional.
While not all home loans include a prepayment penalty within the contract, many do. For those who may be unfamiliar, this penalty is a fee paid by homeowners who pay off their mortgage before the term has ended. Most conventional and government-insured mortgages are either ten, fifteen or thirty-years long. Some mortgage brokers charge a prepayment penalty to make up for some – if not all – of the interest they lose when the borrower pays off their loan early. However, it is rare that a government-insured loan issued by the FAH, USDA or VA charges this type of penalty. As such, a prepayment penalty could be one of several financial consequences of selling your home before one year of ownership, but it is not a given.
In her article “A mortgage prepayment penalty is a fee for selling, refinancing, or paying off your mortgage early” for Business Insider, Laura Grace Tarpley, CEPF elaborates. Tarpley writes that “you probably won’t have to pay a penalty if you pay extra toward your mortgage every month, or if you make supplemental payments here and there.” Homeowners usually only pay prepayment penalties when they either “pay off the mortgage completely by making a large payment, selling, or refinancing, or pay off a huge portion of the mortgage all at once.” There are two types of prepayment penalties: soft penalties and hard penalties. According to Tarpley, a hard penalty means that you will “pay a fee when you sell or refinance” but with a soft penalty, you only pay when you refinance. Some fees are a fixed amount while others are a percentage of the remainder of your loan. If one was included in your home loan, you will find it expressly outlined in the contract.
Last on our list of terms you should know before selling your home after less than a year is “short sale.” Some homeowners who must sell unexpectedly take this path. Miranda Grace explains in her article “What Is A Short Sale In Real Estate? A Guide To The Process” for Rocket Mortgage. Grace writes that a short sale happens “when a homeowner in dire financial trouble sells their home for less than they owe on the mortgage.” This means that the seller does not make a profit and therefore does not owe capital gains tax.
However, it also means that they still owe money to their mortgage broker. A short sale usually happens only with permission from the lender. Once the home has sold, the broker could react in one of two ways. After the lender receives all proceeds from the sale, they “either forgive the difference or get a deficiency judgement.”
A deficiency judgement “requires the original borrower to pay what’s left over.” Homeowners who can no longer afford their mortgage payments might opt for a short sale instead of foreclosing on the property. Foreclosure incurs consequences far beyond the financial loss incurred in a short sale. In general, short sales are less common in a seller’s market and more common when buyers have an advantage.
Ten Reasons Why Homeowners Sell Unexpectedly
#1 They Can’t Afford Maintenance or Repair Costs
One reason why homeowners sell soon after buying is because they either underestimated maintenance costs or cannot afford unexpected but necessary repairs. This is more common when a buyer waives the inspection contingency or fails to obtain a home warranty, but it could happen to any new homeowner. In her article “Home Maintenance – The Cost Buyers Can’t Afford To Ignore” for Forbes, Kim Slowey writes that homeowners should save “1%-4% of [their] home’s purchase price every year” just for routine maintenance. In 2021, the median sale price of a single family home in the United States was a shocking $346,900 – up nearly 17% over 2020 and the highest in over twenty years. A homeowner who purchased their property at this price would need to save between $3,469 and $13,876 per year just to cover the cost of maintenance and repairs.
In some parts of California where weed abatement and debris removal is required by law to prevent devastating wildfires from raging through communities, maintaining one’s property could end up costing homeowners a lot more than they anticipated. Keep in mind that the figures quoted above are just a fraction of the annual cost of homeownership. In addition, the average homeowner must pay 1.07% of the appraisal value of their home each year in property taxes. As such, some homeowners find the cost of maintenance and repairs too much to bear. Those who do might decide to sell early.
#2 Caring for the Property is More Work Than They Expected
Similar to the first in our list of reasons why homeowners sell unexpectedly, some do so because caring for their property is more work than they anticipated. Homeowners with physical limitations, care-taking responsibilities or full-time jobs might not have the time nor the energy to properly care for their house and surrounding land. Those who recently moved from the city to a more rural area might find themselves struggling to keep up with these new responsibilities.
Quoting Fran O’Brien in her article “These People Rushed to Buy Homes During COVID-19. Now They Regret It.” for The Wall Street Journal, Candace Taylor explains. Taylor writes that insurance companies have “seen large, non-weather related losses increase in frequency and severity” over the last two years. According to O’Brien, these losses are due in part to “hasty home purchases” made during the pandemic. For example, Taylor notes that “buyers moving from a small city apartment to a large home in a rural area may not be well versed in how to prevent the pipes from freezing.” O’Brien elaborates, telling Taylor that “‘people are moving to places that they don’t know a lot about.’” Over-eager prospective homebuyers are thinking “‘this looks like a nice place to live,’” but O’Brien notes that these buyers “‘don’t understand what risk there could be with that home.’”
#3 The Mortgage Payments Are Too High
Aside from property taxes and maintenance costs, a homeowner’s mortgage payments might also be too high for them to afford. Each mortgage payment includes a percentage of the loan’s principal and interest as well as taxes and insurance – often called PITI for short. Homeowners who paid less than 20% for their down payment at closing might also be required to pay for private mortgage insurance. All told, monthly mortgage payments could be too expensive – especially for a homeowner on a single income.
Ronda Kaysen explains in her February 2022 article “They Rushed to Buy in the Pandemic. Here’s What They Would Change.” for The New York Times. Kaysen writes that for many homeowners who bought during the pandemic, “the mortgage is a financial strain.” Referencing a recent Zillow survey, Kaysen notes that 21% of new homeowners “thought they overpaid.” Now, those same home buyers are “feeling the burden of a huge mortgage.”
#4 They Need to Relocate for Work or to Care for a Loved One
Some new homeowners need to sell immediately if forced to relocate for work. Others must sell to care for a loved one who recently fell ill, was injured or was devastated by the loss of a spouse, sibling or child. In his article “Who is Moving and Why? Seven Questions About Residential Mobility” for Harvard’s Joint Center for Housing Studies, research analyst Riordan Frost notes that both are fairly common.
Referencing a 2019 survey, Frost writes that 27% of people who moved did so for “family-related reasons” while another 21% did so for “job-related reasons.” As such, both job relocation and caring for family members are frequent reasons why selling a house unexpectedly is necessary — even if they stand to lose money in the sale.
#5 The Neighborhood Changed Suddenly
Sometimes, a neighborhood changes suddenly. Other times, new laws are passed that allow future changes to the neighborhood that are not in line with a homeowner’s preferences and original expectations. For example, changes to zoning requirements might allow commercial development in a previously residential neighborhood. Some homeowners might choose to relocate simply because disruptions to their everyday lives – i.e. noise and increased traffic from construction – are too much to bear. Other issues – such as an uptick in property crime or a natural gas leak – could also lead certain homeowners to sell early.
#6 Their Relationship with a Co-Owner Changed
An unexpected change in one’s relationship with their co-owner could also result in the sale of one’s home after less than a year. Perhaps a co-owner passed away, a sibling decided to relocate or a romantic relationship broke up. Either way, such changes could make it impossible for one co-owner to pay the entire monthly mortgage and maintenance costs. In some cases, a preexisting cohabitation agreement might require the couple to sell and split profits. We explain how homeowners can protect themselves in the event of a co-owner death, falling out or mutual separation in our article “Everything You Need to Know About Co-Owning a House.”
#7 The House Does Not Fit the Owners’ Lifestyle
Sometimes, homeowners simply purchased the wrong property. Perhaps their new home is too far from family and friends, from their favorite restaurants or from the organizations they love to volunteering for. Zach Wichter explains that Millennial homebuyers are most likely to struggle with this after a pandemic impulse buy in his article “Nearly two-thirds of millennials have homebuyer regrets, survey finds” for Bankrate.
Referencing a recent Bankrate survey, Wichter writes that many Millennial respondents “came to realize their new place was literally not the right fit.” Fifteen percent of Millennial respondents said they bought a house in the wrong area for their lifestyle. Furthermore, “around 30 percent felt the home was not the right size.” 14% said their home was too big while another 14% said it was too small.
#8 They Were Injured or Fell Ill
According to Deb Gordon in a recent article for Forbes, “50% of Americans now carry medical debt.” That’s up 4% from 2020, but the real percentage could be quite a bit higher. Gordon writes that this number does not include “credit card balances and unpaid medical bills that haven’t hit consumers’ credit reports.” Unfortunately, prospective homeowners who apply for mortgages while carrying medical debt are often rejected by lenders. In a December 2019 article for CNBC, Sharon Epperson and Lorie Konish reference a Zillow survey from the same year. Epperson and Konish note that Zillow’s survey found “38% of buyers who owe money for health-care expenses…[were] turned down for a mortgage because of medical debt.”
Medical debt due to injury and/or illness does not just impact a buyer’s mortgage eligibility. It can also affect a homeowner’s ability to pay their mortgage. Some homeowners who are hit with medical bills they cannot afford or struck by sudden illness that prevents them from working default on their loans. Homeowners in a buyer’s market might pursue a short sale while those in a seller’s market might swallow their prepayment penalty and hope for a tidy profit that covers their bills. Thankfully, many mortgage lenders will work with borrowers who fall ill or are injured through financial aid called “mortgage forbearance.” We explain this in further detail in an upcoming post.
#9 Internet Access Was Inadequate
During the COVID-19 pandemic, more Americans worked from home than ever before. Remote and hybrid work are now ubiquitous across a variety of industries. However, some homeowners purchased properties without researching internet service providers. Now, some remote workers are stuck in dead zones with such poor connections that they cannot possibly work from home. Because of this, some homeowners have chosen to sell and move on.
#10 Their Family Expanded or Will Soon Expand
One homeowner might list his or her house for sale, so they can move across the country and take care of a sick relative. Another homeowner might sell to buy a property that better accommodates a new baby or an aging parent.
Here’s What Might Happen if You Sell Your House Before One Year of Ownership
#1 You Might Owe Short Term Capital Gains Tax
As mentioned above, homeowners who sell before one year of ownership might owe capital gains tax. Homeowners who sell before a year of ownership only owe capital gains taxes when they make a profit on the sale of their home. However, they cannot avoid capital gains tax like homeowners who sell after two years and make less than $250k or $500k in profit.
In some circumstances, they might be able to claim a partial exclusion on their taxes. The IRS explains that homeowners who must sell due to a mandatory job relocation, unexpected illness or other unforeseen issue can claim a partial exemption. Learn all about how to avoid paying capital gains taxes on your primary residence if selling your house before one year here.
#2 You Might Owe a Prepayment Penalty to Your Mortgage Lender
As mentioned above, some homeowners who sell before the term of their loan is up could face prepayment penalties. Mortgage lenders charge a prepayment penalty to make up for lost interest payments they would have profited from had the loan been paid off over ten, fifteen or thirty years. In his article “Prepayment Penalty: What It Is And How To Avoid One” for Forbes, Dock David Treece explains how much borrowers can expect to pay.
Treece writes that “prepayment penalties typically start out at around 2% of the outstanding balance if you repay your loan during the first year.” Most loans cap their penalty at 2% but “some loans have higher penalties.” According to Treece, these penalties “then decline for each subsequent year of a loan until they reach zero.” Homeowners should keep in mind that “federal law prohibits prepayment penalties for…FHA and USDA loans,” so be sure to check with an attorney if your lender demands such a fee.
#3 You Might Need to Pay Real Estate Agent Commission Fees and Other Closing Costs
As the seller, you will probably owe real estate commission fees and some other closing costs. In her article “Who Pays Closing Costs, Buyer Or Seller?” for Quicken Loans, Victoria Araj explains that buyers pay most of the smaller closing costs. They usually pay title fees, loan origination fees, insurance fees, settlement fees, inspection fees and more. You can learn all about what buyers owe in our article “How Much Are Closing Costs for Home Buyers?.” Sellers – on the other hand – are usually responsible for paying commission to both the listing agent and the buyer’s agent.
According to Araj, “that generally amounts to average closing costs of 6% of total purchase price or 3% to each agent.” In some states, the real estate agent commissions alone could add up to more than the buyer’s total closing costs. When operating a hot seller’s market such as this, homeowners could get the buyer to pay real estate agent fees – depending on the local market.
Other Costs of Selling a House
In addition to the commission you pay real estate agents and capital gains tax you owe, there are a few other selling costs you might expect. Depending on the state of the market and the condition of your home, you might pay for minor repairs or for a presale home inspection. You might also pay for staging. Depending on the deal you make with the buyer of your home, you might also pay a share of annual property taxes.
#4 You Might Need to Pay the Balance of Your Mortgage
If you lose money on the sale of your home and do not recoup enough to pay off your mortgage, you might need to pay the balance out of pocket. This usually happens when your home loan includes a due-on-sale clause in its contract. Tony Guerra explains in his article “What Happens If I Sell My House & Got Less Than I Owe to the Mortgage Company?” for SF Gate. First, Guerra writes that the due-on-sale clause included in many home loans “ensures mortgage lenders’ loans are fully paid off when their borrowers sell their homes.” If your loan contract includes this clause, and you sell for less than the balance of your mortgage, “your lender could demand the difference from you.”
In the case that the seller cannot pay the balance and the lender refuses additional financing, the originator of the loan could refuse to “release their liens.” This could result in a title issue for the buyer, causing the sale to fall through or lead to a seller-buyer dispute. Should the current homeowner opt for a short sale, their lender might forgive the remaining balance once the property has sold.