Ten Things You Need to Know About Capital Gains Tax on a Home Sale
You may already know that, if you sell your property, you may exclude up to $250,000 of your capital gain from your taxes. Most home owners do not pay tax on a home sale. This is because the Internal Revenue Service lets you exclude gains of up to $250,000 from your tax return, not every property qualifies for the exemption, however, and there are limits on how often you can claim the benefit. Here are the top ten facts every home seller should know about this generous tax exclusion.
#1: The exclusion only applies to main homes. Your main home is the one you live in most of the time. If you own and live in more than one property, you can nominate any one of them as your main home. However, you can’t be disingenuous to get the tax concession. The IRS applies certain tests to make sure the home you nominate is your primary residence. Where you work, where other family members spend a major part of their time and where you vote all play a part in determining your main residence.
#2: To claim the exemption, you must live in the home for at least two out of the five years before you sell. The 24 months do not have to run concurrently. So, you could live in the property for 18 months, move out for a year, then move back in for a further six months and still claim the home sale exclusion.
#3: You must own the home for at least two out of the past five years. The same test applies.
#4: The ownership and residency tests don’t apply in “unforeseen circumstances.” Unforeseen circumstances are unpredictable events that happen at short notice and affect your ability to remain in your home. So, serious ill-health, divorce, a family death or your job moving more than 50 miles away count as unforeseen circumstances. If you experience any of these events, you can still claim the home sale exclusion even if you sell your home before the two year qualifying period is up.
#5: Your maximum deduction may be less than $250,000. Most home owners can deduct all of their gain up to $250,000. However, home owners who claim an unforeseen circumstances exclusion can make only a partial deduction based on their occupancy. So, a home owner who lives in her house for the full two years before a home sale can deduct the first $250,000 of profit from her taxable income. A home owner who gets divorced and moves out after just six months can claim one-fourth of that amount or $62,500.
#6: Married couples who file joint returns can deduct up to $500,000 of gain. Both spouses must live in the property for at least two out of the five years immediately preceding the sale. They do not, however, have to co-own the property — only one spouse needs to meet the two-out-of-the-last-five-years ownership test.
#7: There’s no limit on the number of time you can use the tax break. The main residence tax exclusion is not a one-time deal. Qualifying home owners can buy a home, live in it for two years, sell the home and exclude the capital gain– then repeat the process. You can keep repeating the process as many times as you please.
#8: Your gain might be lower than you think Many of the expenses you incur in selling your home and improving it over the course of your ownership can be deducted from the sale price to reduce your net taxable gain. For example, you can deduct appraisal fees, advertising fees, escrow fees, notary fees, broker’s commission, title search fees and other closing costs. You can also deduct the cost of capital improvements such as adding a new kitchen, upgrading the heating system or fitting a wall-to-wall carpet. Regular home repairs that simply keep your property in operating condition, such as fixing broken guttering, can’t be deducted. These deductions can slice a lot of cash from your tax bill, as the example below shows. This home owner can deduct all of his gain despite making a headline profit of $300,000 on the home sale.
#9: In most cases, you don’t have to report the gain Home sellers who can exclude their gain don’t need to report the home sale to the IRS. However, you must report the gain if you can exclude only part of it or if the IRS sends you an informational income reporting document such as form 1099-S.
#10: Home sale losses are not tax deductible Tax law does not allow taxpayers to deduct a home sale loss from their taxable income. The exclusion applies only to capital gains.