Will You Owe Capital Gains Tax After Selling Your Home?

With homes appreciating so much in the past year, you might wonder if selling will leave you with a hefty capital gains tax. Will you owe Uncle Sam? If so, how much? The good news is that a law passed in the late 90s states that you may exclude up to $250,000 of your capital gain from tax (or up to $500,000 for married couples filing joint tax returns). You can claim this exclusion once every two years. Here are the specific stipulations:

∙ You owned the home and lived in it as your primary residence for at least two of the previous five years.
∙ You did not own your home through a like-kind exchange (also known as a 1031 exchange) in the past five years.
∙ You did not claim any exclusion for the sale of a home that occurred during a 2-year period ending on the date of the sale of the home, the gain from which you now want to exclude.

What is Your Gain?

First, let’s calculate your gain. If you and your spouse bought a house for $200,000 and sold it years later for $750,000, you made $550,000 profit (before cost of sale expenses). You might think you’re $50,000 over the $500,000 tax exclusion limit for married couples, but it isn’t so simple. You need to calculate your gain this way:

Home selling price minus closing costs, selling costs, and your tax basis in the property (your original purchase price plus purchase expenses, plus the cost of home improvements, minus any depreciation, and minus any casualty losses or insurance payments).

In the same example, let’s say you invested $80,000 in improvements to the house, spent another $2,000 getting the home in shape for sale, and paid $37,500 in commissions. Calculate gain as follows:

$750,000 – $80,000 – $2,000 – $37,500 – $200,000 = $430,500

Since $430,000 in gains falls below the $500,000 maximum exclusion for married couples, you’re free of capital gains tax, provided you’ve met the stipulations mentioned earlier.

Partial Exclusions from Tax Gains Are Possible

What if you didn’t live a full two years out of the last five in your home because of an unforeseen circumstance such as divorce, health reasons, job loss, or because your family expanded rapidly with multiple births? The government allows for partial exclusions on capital gains for a wide range of life circumstances that caused you to move before living in a home for two years. You can still get a partial exclusion based on the portion of the two-year period that you lived there. To calculate it, take the number of months you lived there before the sale and divide it by 24. Then multiply it by $250,000 or $500,000 (single or married filing jointly, respectively).
To illustrate, let’s say a single woman sold a home for a profit, but only lived in the home for one year before moving because of a job loss. Let’s calculate the portion of capital gains she can exclude from taxes:

12/24 (lived there 12 months out of two years) x $250,000 (exclusion for single person) = $125,000

She may exclude up to $125,000 of her gain, 50% of the regular $250,000 exclusion for singles. For complete information on tax exclusion rules, go to this IRS site.Publication 523 – Selling Your Home

Real Estate Term of the Week

Capital Gains Tax: A tax levied on profit from the sale of property or of an investment.

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