The Tax Implications of Selling a Home

It’s easy to find tips for selling your home – but have you looked into capital tax gains? Sellers who have successfully sold their home may have to pay taxes on the profits from the sale. Here’s what you need to know about your tax obligations following a sale.

WHAT ARE YOUR TAX OBLIGATIONS AFTER SELLING YOUR HOME?

You generate capital gain after selling an asset for a net profit based on the amount you spent to acquire it. Your home qualifies as an asset and is therefore subject to capital gains tax. According to IRS classifications, capital gains fall under two categories, with most real estate sales falling into the second category:

• Short-term capital gains apply if you have only owned an asset for a year or less.
• Long-term capital gains apply when you have owned an asset for more than a year.

If you have sold your home for substantially more than you paid for it, the profits from the sale may be subject to capital gains tax. But there’s more to it than subtracting the purchase price from the sale price to determine capital gain, which refers to the the difference between cost basis and net proceeds:

• Cost basis is the amount that you spent to acquire an asset such as your home. Aside from the purchase price, it also covers acquisition costs and capital improvements. For example, if the purchase price of the home was $210,000 and you paid $5,000 in lender fees and other related expenses, the cost basis is $215,000. You can also include home improvements, additions, renovations, and upgrades that boost property value in the computation of cost basis, even if the improvements were made after you purchased your home.
• Net proceeds refers to the amount your home sold for, after deducting real estate commissions and other expenses related to the sale. For example, if you sold your home for $300,000 but paid $25,000 in commission, closing costs, and other expenses, the net proceeds would be $275,000.

However, there are exceptions – if the home served as your primary residence, you may not be required to pay capital gains tax up to an amount specified by the Internal Revenue Service (IRS). Many sellers are eligible for capital gains tax exclusion depending on whether they sold a primary residence, vacation home, or investment property, and whether its value has significantly appreciated over time.

The IRS has a list of expenses that can and can’t be included in the computation of cost basis as well as a test for exclusion eligibility.

WHAT IS HOME SALE GAIN EXCLUSION?

The home sale gains exclusion, also known as primary residence exclusion, allows sellers to exclude $250,000 to $500,000 of their capital gains from taxation following the sale of a primary residence. To be eligible, your home must have served as your primary residence for at least two of the last five years.

Those two years don’t need to have been continuous and can fall anywhere within the five-year period. The IRS only requires a total of 24 months. For married couples filing jointly, both spouses must meet the residence requirement separately in order to qualify for full exclusion.

You must also demonstrate that you have owned the home for at least two of the last five years leading up to the sale, though the primary residence and ownership requirements don’t need to have occurred in those same two years.

Moreover, you should not have claimed a home sale gain exclusion on another property within a two-year period preceding the sale. For married couples filing taxes jointly, only one spouse needs to meet the two-year ownership requirement.

HOW DOES IT WORK?

Aside from calculating cost basis and net proceeds, how you file your taxes can impact capital gains tax exclusion, particularly if you are filing jointly as a couple ($500,000) or solo ($250,000) as someone who is unmarried, any capital gains in excess of the threshold will be subject to capital gains tax.

There are also some automatic disqualifications that can prevent you from claiming exclusion. The sale of your home may not eligible for tax exclusion if any of the following apply to your circumstances:

• If you acquired your home through a 1031 exchange (or like-kind exchange) within the last five years, exclusions don’t apply.
• If you are subject to expatriate tax, you may not be eligible for exclusions. Expatriate tax applies to U.S. citizens who have renounced their American citizenship as well as long-term U.S. residents who have ended their resident status for federal tax reasons.

For more information on capital gains tax, home sale gain exclusion, and general tips for selling your home, Berkshire Hathaway HomeServices (BHHS) Caliber Realty is here to help. Call us at 979.694.8844 or send us an email here.