Capital gain

Key Takeaways

• A capital gain is the amount realized on a sale minus the property's adjusted basis, not simply the sale price minus the original purchase price.
• Adjusted basis rises with capital improvements and falls by depreciation the owner has already deducted on a rental or business property.
• Federal law lets a qualifying seller exclude up to $250,000 of gain on a main home, or $500,000 on a joint return, after owning and living in it at least two of the five years before the sale.
• Washington's capital gains excise tax does not reach a direct sale of real estate, because RCW 82.87.050 exempts real estate transferred by deed.

What It Means

A capital gain is the profit on the sale of a capital asset: the amount realized minus the asset's adjusted Basis. For real estate, the amount realized is the selling price less the costs of selling, such as broker compensation, escrow and title charges, and transfer taxes. Adjusted basis starts at what the owner paid to acquire the property, rises with capital improvements like a new roof or an added room, and falls by depreciation the owner has already deducted on a rental or business property.

Two habits of thinking cause most of the errors students make here. The first is treating gain as sale price minus purchase price. Selling costs and improvements both move the number, usually downward, and skipping them overstates the gain. The second is assuming a gain automatically means tax due. Federal law excludes a large share of the gain on a main home for sellers who qualify, so many homeowners realize a substantial gain and owe nothing on it. See Capital Gains Exclusion for how that exclusion is earned.

Gain on an asset held longer than a year is long term, which is the category real estate normally falls into and the one that carries the lower federal rates. Gain on an asset held a year or less is short term and is treated less favorably.

How It Works in Washington

Washington does have a capital gains excise tax, and it does not apply to an ordinary sale of real estate. Chapter 82.87 RCW imposes an excise tax on the sale or exchange of long term capital assets, payable only by individuals, equal to seven percent of an individual's Washington capital gains, with an additional 2.90 percent on the portion exceeding $1,000,000 effective January 1, 2025 (RCW 82.87.040). RCW 82.87.050 then exempts all real estate transferred by deed, real estate contract, judgment, or other lawful instruments that transfer title to real property and are filed as a public record with the county where the real property is located. A Washington seller's gain on a house, a lot, or a rental conveyed by deed sits outside that tax. The exemption narrows when what is sold is an interest in a privately held entity rather than the real estate itself, reaching only the portion attributable to real estate the entity owns directly (RCW 82.87.050(2)).

Do not let a client confuse either tax with Washington's real estate excise tax at closing. REET is measured on the selling price under RCW 82.45.060, so a seller owes it on a losing sale as readily as on a profitable one, and it lands among the seller's Closing Costs. See Washington Capital Gains Tax for the state tax on its own terms, and this guide to Washington's evolving tax landscape for how brokers explain the difference. Explain the mechanics, then send the client's numbers to a CPA.

Example

Elena and Marcus bought a Vancouver, Washington house in 2016 for $335,000 and have lived in it ever since. In 2021 they spent $46,000 on a kitchen and bathroom remodel, a capital improvement, so their adjusted basis is $335,000 plus $46,000, or $381,000.

They sell in 2026 for $690,000. Broker compensation, escrow and title fees, and the state and local real estate excise tax come to $58,000, so the amount realized is $690,000 minus $58,000, or $632,000. Their capital gain is $632,000 minus $381,000, or $251,000. Look at what separates the $690,000 price from the $251,000 gain: $439,000, made up of their $381,000 adjusted basis and $58,000 of selling costs.

They file a joint return and owned and used the house as their main home for at least two of the five years before the sale, so federal law lets them exclude up to $500,000 of gain. Their $251,000 gain fits inside that, and no federal tax is due on it. Washington's capital gains excise tax never entered the analysis, because RCW 82.87.050 exempts real estate transferred by deed. The Washington tax they did pay is the real estate excise tax, already inside the $58,000 of selling costs, and it was charged on the $690,000 selling price rather than on the $251,000 gain.

Common Mistakes and Exam Traps

• The real estate excise tax is not a capital gains tax. Washington measures REET on the selling price under RCW 82.45.060, whether the seller gained or lost on the sale.
• Washington's capital gains excise tax exists under chapter 82.87 RCW but exempts real estate, so telling a Washington seller the state will tax the gain on a house sale is wrong.
• Selling costs reduce the amount realized, which makes the gain smaller than sale price minus purchase price. Distractors usually offer that simpler subtraction.
• Depreciation deducted on a rental lowers adjusted basis, which increases the gain on sale even though the owner never received that amount in cash.