Selling your home? Understanding the tax implications
You've thought long and hard about it and have decided: It's time. You're going to sell your house. And while this can be an exciting time, it also comes with a whole host of questions. Should I use an agent? (The answer is yes, and we can recommend some very good ones if needed). How much should I list it for? Can I afford a new place? (We can help with this last question).
All of these are important. But one thing you need to consider is this: Do you have to pay capital gains tax on the proceeds of your home sale?
Years ago, one had an option of rolling the proceeds from the sale of their home within two years into a new home. The Taxpayer Relief Act of 1997 changed all of that.
Today, through the Home Sale Tax Exclusion, one could actually sell their home and pay zero capital gains taxes. No purchase of another house is required for the exclusion.
This important exclusion helps most homeowners steer clear of large taxes on the sale of their home.
Here’s how it works:
Qualification for the Tax Exclusion
To qualify for this huge tax break, homeowners must do a couple things. First, they must own their home individually or with a spouse. This may seem like an obvious distinction, but I’ve seen some weird forms of ownership over the years that could interfere with that person’s ability to qualify for the exclusion. Second, they must have used the home for two years as their primary residence. This two-year period is the minimum time that the homeowner must have lived at the property in five years, giving flexibility to those who have moved away temporarily1
What if I lived in my house all of 2012, rented it out in 2013, and then moved back in 2014 and sold it in March of 2018? You would still qualify. You meet the two out of five year rule.
Another key factor of this exclusion is total profit. The exclusion can only be applied up to $250,000 for a single individual or can be extended to $500,000 for married couples that file their taxes jointly. Note that this is profit, not total value. A person can sell a home for $900,000 and still qualify if he or she originally paid $700,000 for the house.
Ralph and Alice bought their home in 2010 for $700,000. Five years later, they meet the holding period requirement and sell their home for $1.3 million. This is a gain of $600,000. Seems like they don’t qualify as they are over the $500,000 limit.
However, they put an addition on the house that cost $150,000 which can be added in to their cost. This is where your CPA can come in handy. They can help determine what types of improvements count toward the exclusion.
Not Qualifying for the Exclusion
If one of the rules for this exclusion isn't met, the seller does not qualify for this tax break. He or she will be required to pay capital gains tax on the profit from the sale of the property. But how much?
That depends.
Capital gains are based on income, with most Americans paying a maximum of 15%. Those making over $492,300 will pay 20%. This tax can take a big chunk of people’s profit from their home sale. Making decisions that keep one in line with the exclusion can save thousands when it is time to sign contracts and transfer ownership2
What if after determining you still made too much on the sale and you owe some capital gains tax? Not all is lost as you can offset that gain with other long-term capital losses realized during the year of the sale of other assets that you own.
One question I get from time to time is when one inherits a house. How does the tax implications work with that?
When one inherits an asset, be it a house or a stock portfolio, one’s cost is the value on the date of death (another option is available but most use the date of death). Let’s say Maggie inherits her uncle’s house with a date of death value of $500,000. She sells it a year later for $600,000. She has a $100,000 long term capital gain and would be subject to ordinary capital gains tax rates.
A Valuable Perk for Homeowners
This exclusion helps most homeowners avoid paying high taxes on selling their home. If you’re considering selling your home and aren't sure if you might have to pay taxes, give me a call and we can walk through it together.
Any questions, I am here to help.
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All the best.
Rick Fingerman, CFP®, CDFA™, CCPS®
Rick@PlanWithFPS.com
617-630-4978
1. https://www.irs.gov/taxtopics/tc701
2. https://www.investopedia.com/ask/answers/06/capitalgainhomesale.asp
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