Will I have to pay taxes when I sell my home?
This is one of the most common questions we receive from sellers that are concerned with paying capital gains when they sell a home.
You list your house for sale and hope for the best. Then fortune smiles on you and you sell it for a tidy profit. It can be tough to turn right around and give a healthy percentage of that profit to the Internal Revenue Service, but the IRS isn’t heartless. You may be able to keep most – if not all – of that money. You can exclude it from your taxable income using the home sale exclusion.
$250,000 to $500,000 Exclusion on the Sale of a Primary Residence
Unmarried individuals can exclude up to $250,000 in profit from the sale of their main home, and you can exclude $500,000 if you’re married and file a joint return with your spouse.
So if you’re single and you realize a $200,000 profit on the sale, you don’t have to report any of it as taxable income because this is less than the $250,000 exclusion amount you’re entitled to. If you realize a $255,000 profit or gain, you must report $5,000 of it as income.
The IRS details this further in Publication 523, Selling Your Home
Of course, the exclusion isn’t automatic. The IRS imposes a few rules.
The 2-Out-Of-5-Year Rule
You must have lived in the home for a minimum of two years out of the last five years immediately preceding the date of the sale, which typically means you can’t use the exclusion on the sale of rental or business property. The two years don’t have to be consecutive, however. You might live in the home for a year, rent it out for three years, then move back in for 12 months just prior to its sale. The IRS figures that if you spent this much time under that roof, the home qualifies as your principal residence.
You can use this 2-out-of-5-year rule to exclude your profits each time you sell your main home.
Of course, this generally means that you can claim the exclusion only once every two years because you must spend at least that much time in residence, but some exceptions do apply. If you lived in your home less than 24 months, you may be able to exclude at least a portion of the gain.
A Change in the Location of Your Job
If you lived in your house for less than two years, you can exclude a part of your gain if your work location changed.
This exception would apply if you started a new job or if your current employer requires you to move to a new location.
If you’re selling your house for medical or health reasons, document these reasons with a letter from your physician. This, too, allows you to live in the home for less than two years. You don’t have to file the letter with your tax return, but keep it with your personal records just in case the IRS wants further information.
You will also want to document any unforeseen circumstances that might force you to sell your home before you’ve lived there the requisite period of time. According to the IRS, an unforeseen circumstance is “the occurrence of an event that you could not reasonably have anticipated before buying and occupying your main home.” These events might include natural disasters, acts of war, acts of terrorism, a change in your employment or unemployment that left you unable to meet basic living expenses, death, divorce or separation, or multiple births from the same pregnancy.
The Partial Exclusion
You can calculate your partial exclusion based on the amount of time you actually lived in your home. Count those months, then divide the number by 24.
Multiply this ratio by $250,000 or by $500,000 if you’re married. The result is the amount of gain you can exclude from your taxable income.
For example, you might have lived in your home for 12 months, then you had to sell it because your employer asked you to relocate to a different office in another state. You’re not married. Twelve months divided by 24 months comes out to .50. Multiply this by your maximum exclusion of $250,000. The result: you can exclude up to $125,000 or 50 percent of your profit.
If your gain is more than $125,000, you would include only the amount over $125,000 as taxable income on your return. If you realize a $150,000 gain, you would report and pay taxes on $25,000. If your gain is equal to or less than $125,000, you can exclude the entire amount from your taxable income.
Suspension of the Five-Year Period for Military
If you or your spouse are on qualified official extended duty in the Uniformed Services, the Foreign Service or the intelligence community, you may elect to suspend the five-year test period for up to 10 years. An individual is on qualified official extended duty if for more than 90 days or for an indefinite period, the individual is:
- At a duty station that’s at least 50 miles from your main home, or
- Residing under government orders in government housing.
Reporting the Gain
Gain on the sale of your home is reported on Schedule D as a capital gain. If you owned your home for one year or less, the gain is reported as a short-term capital gain. If you owned your home for more than one year, it’s reported as a long-term capital gain. Short-term gains are taxed at the same rate as your regular income while the rates on long-term gains are more favorable: zero, 15 or 20 percent, depending on your tax bracket.
Calculating Your Cost Basis and Capital Gain
The formula for calculating your gain involves subtracting your cost basis from your selling price. Start with what you paid for the home, then add the costs you incurred in the purchase, such as title and escrow fees and real estate agent commissions. Now add the costs of any improvements you made, such as replacing the roof or furnace. Subtract any accumulated depreciation you may have taken over the years, such as if you ever took the home office deduction. The resulting number is your cost basis.
Your capital gain would be the sales price of your home less your cost basis. If it’s a negative number, you’ve had a loss. Unfortunately, you cannot deduct a loss from the sale of your main home.
If the resulting number is positive, you made a profit. Subtract the amount of your exclusion and the balance is your taxable gain.
Please, remember that this is not tax advice. It does serve as a starting point for you and we highly recommend that you speak with a tax professional to fully understand all of the details before selling your home.
Contact your San Diego Realtor, Glen Henderson today if you have any additional questions regarding this article or in general about selling your home.