If you are preparing to sell your home, you might be wondering about capital gains tax implications. There is a good chance you will not owe any capital gains taxes on the sale of your principal residence if you meet certain federal requirements. If you do owe tax, the amount of capital gains that you pay on will be significantly reduced.
Most people living in a primary residence qualify for a capital gains exclusion of $250,000 for single filers or $500,000 for married filing joint filers. This could potentially allow you to get tax-free profit on the sale of your home of up to the amount allowed for your filing status.
To qualify for the home sale exclusion, you must pass the following requirements:
You must have owned the home for two of the past five years before the date of sale.
You must also have used the home as your primary residence for two of the previous five years prior to the date of sale.
This exemption is only allowable once every two years.
An example of calculating capital gains tax on a home sale:
Let's say you bought your house for $415,000, put in $50,000 in improvements, and had related fees and costs of another $20,000. This gives you a cost basis of $485,000. If you expect to sell the house for $750,000, the potential capital gain would be $265,000. If you are married and meet both the ownership and use tests, you could exclude the entire gain from your taxable income. However, if you are single, the exclusion only goes up to $250,000, so you would owe capital gains taxes on $15,000. (For simplicity purposes, we're assuming that there are no recapture depreciation concerns).
Reporting the gain
You will still need to report the gain on your tax return, even if it's excluded from your income. The information needed will be found on Form 1099-S you receive, "Proceeds from Real Estate Transactions." The IRS receives a copy of this informational form as well, therefore you need to let them know that you qualify for the exclusion of the capital gain. You can do this by reporting the income and claiming the exclusion on your tax return.
Unfortunately, capital losses on the sale of personal property - including your primary residence home - are not deductible for tax purposes. You will not have to pay any additional tax if you suffer a loss on the sale of your property, but you won't get a tax break for it either.
Converting a second home to a primary residence
Although the rule allows homeowners to take up to $500,000 of profit tax-free, it only applies to the sale of your primary residence. It has been possible to extend the tax break to a second home by converting it to your primary residence before you sell. Once you live in the second home for two years, you will be able to exclude up to $500,000 of profit again. This allows savvy taxpayers to claim the exclusion on multiple homes.
As with any tax situation, there are exceptions that may disqualify you. Double-check with your tax professional before assuming that you qualify for this exemption.