Capital Gains, the Texas Tax Advantage, and What Houston Sellers Should Know Before They List

Texas is one of the most tax-favorable states in the country for homeowners who sell. No state income tax means the capital gains conversation is simpler here than in California, New York, or states where a sale can trigger both federal and significant state tax obligations. But simpler does not mean simple, and the federal rules around capital gains on a home sale have enough nuance that sellers who do not understand them can leave meaningful money on the table or face unexpected tax bills.

I am a REALTOR®, not a CPA, and nothing here is tax advice for your specific situation. What I can do is explain the framework so you go into the conversation with your tax professional informed rather than starting from zero.

The Section 121 Exclusion: What It Is and How to Qualify

Under Section 121 of the Internal Revenue Code, a seller who has owned and used their home as their primary residence for at least two of the five years preceding the sale can exclude up to $250,000 of capital gain from federal income tax. For married couples filing jointly, the exclusion is $500,000. This is one of the most valuable tax provisions available to ordinary individuals, and most primary residence sellers in Houston who have owned their home for more than two years qualify for it.

The “owned and used” requirement does not need to be two continuous years. The two years can be accumulated over the five-year window, which matters for people who moved out of their primary residence but have not yet sold it. It also matters for people who bought a home as an investment or rental property and later converted it to their primary residence — the two-year clock for the use requirement begins on the conversion date, not the purchase date.

The exclusion applies to each sale of a primary residence. There is a general rule that you cannot use it more than once every two years, but in most practical situations this is not a constraint for sellers in Houston’s market.

Calculating Your Capital Gain in Texas

Capital gain on a home sale is the difference between your adjusted basis and your net sale price. Your adjusted basis starts with what you paid for the home and increases with the cost of capital improvements you made during ownership. Adding a room, replacing the roof, upgrading the HVAC, installing a pool — these are capital improvements that increase your basis and reduce your taxable gain. Routine maintenance — painting, replacing fixtures, landscaping maintenance — does not increase basis.

Keeping records of capital improvements is worth the effort for any homeowner who may eventually sell at a gain. In Houston’s market, where substantial appreciation has occurred in many corridors, the difference between a carefully documented basis and an undocumented one can be tens of thousands of dollars in taxable gain. I encourage sellers to pull their records before listing so their CPA has the full picture.

Your net sale price for gain calculation purposes is your gross sale price minus selling expenses — commissions, title costs, and certain other closing costs you pay as the seller. These reduce the gain, which means your selling costs are not entirely neutral from a tax perspective; they reduce what the IRS taxes.

The Texas Homestead Exemption and What Sellers Should Know

Texas’s homestead exemption reduces the appraised value of your primary residence for property tax purposes by $100,000 (as of recent legislative changes), which lowers your annual tax bill while you own the home. It also caps how much the appraised value can increase year over year, which in a rapidly appreciating market can mean your tax basis is meaningfully below market value.

When you sell, the exemption ends. The new buyer applies for their own exemption. The property will be re-appraised for the following tax year at or near sale price, which is relevant for the tax proration calculation at closing — if your assessed value has been significantly below market due to the homestead cap, the buyer’s future tax burden will increase, and a sophisticated buyer may factor this into their offer calculation.

When the Gain Exceeds the Exclusion

If your capital gain exceeds the Section 121 exclusion — $250,000 single or $500,000 married — the excess is taxable at federal capital gains rates. Long-term capital gains rates (for property held more than one year) are currently 0%, 15%, or 20% depending on your income level. High-income sellers may also owe the 3.8% Net Investment Income Tax on the excess gain. This is the calculation that makes a conversation with a CPA essential before listing a high-appreciation home.

Sellers in this position have options worth exploring with a tax professional: timing the sale to fall in a lower-income year, a 1031 exchange if the property is investment property rather than primary residence, charitable giving strategies for very high-gain situations, and installment sale structures in specific circumstances. None of these is a universal answer, and all of them require professional guidance specific to your financial situation. What I can do as your agent is make sure you are having that conversation before you list rather than after you close.