If you are preparing to sell your home, you should be aware of the capital gains tax implications. There is a good chance that you will not owe any capital gains taxes on the sale of your principal residence if you meet certain federal requirements. And, if you do, the amount of capital gains that you pay on will be significantly reduced.
Capital Gains Taxes on the Sale of a Home
The capitals gain, or real estate profit, is calculated by deducting the price you paid for your home from the sales price. Other potential deductions include any major home improvements or costs incurred while preparing to sell (keep your receipts!), the commission you paid to sell your house, and any closing costs you paid to purchase it originally and to sell it now.
If you are single or are married but file taxes individually, you do not have to pay income tax on real estate profits unless they exceed $250,000. For married couples who file jointly, the exclusion increases to $500,000.
To qualify for these tax exemptions on your home sale, you must meet the following IRS requirements:
- Owned the home for at least 2 years (ownership test)
- Lived in the home as your primary resident for two out of the past five years prior to the sale (use test)
If you own two homes and split your time between them, your primary residence is the one that you live in for the majority of the time. Thus, the two-year residency requirement doesn’t have to be consecutive – you just need to have resided in your home for a total of 24 months out the five years prior to the sale.
You cannot claim the capital gains exclusion if you previously claimed it for the sale of another home within two years of the sale of your home. Additionally, if you sell your home for less than you owe on it, you cannot deduct that loss unless you turn it into a rental property. Speak with an accountant to get the specific rules here.
If you plan on selling your home and received a first-time homebuyer credit (applicable to homeowners in Maryland), you must repay the full amount of the credit if the property is no longer your primary residence within three years of the date of purchase.
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Exception to the Rules
There are few exceptions to the rules for claiming the capital gains exemption. An example would be if you had to move before owning the home for two years because of a job change or because you experience what the IRS designates as an “unforeseen circumstance,” such as a divorce or natural disaster. In these situations, the IRS will allow you to prorate the exclusion.
Calculating Capital Gains
Let’s say you bought your house for $400,000, put in $75,000 in improvements, and had related fees and costs of another $10,000. 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 met 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.
Non-residents may have income tax withheld at settlement until you pay next years taxes. Also, if you worked from home or used part of the property for business and wrote it off during that time, you will be taxed on that percentage of the profit. Furthermore, if you rented your home out and depreciated it, you may be responsible for paying taxes on the depreciated amount unless you sell the property through a tax free exchange.
A tax free exchange allows you to sell investment property and purchase other similar property without paying any capital gains tax on the property you sold. I sold a rental property in Hawaii in 2006 and put the proceeds into an exchange account from which I purchased a rental property in Galveston, Texas. I paid no taxes on the sale due to this kind of exchange.
If you have extenuating circumstances that may affect your capital gains, you should contact a certified public accountant or tax attorney for professional guidance.
**DISCLAIMER: Always seek legal counsel from a tax professional. Information is deemed reliable but not guaranteed.**If you would like help getting top dollar for the sale of your home, contact the Eric Stewart Group today. For the past 30 years, we have been helping clients across the DC metro area successfully navigate the complexities of a real estate sale. For additional tips, download our FREE Market Ready Guide.
