With median sales prices for existing homes hitting record highs this year, many homeowners are contemplating selling their properties. Even those who purchased their homes less than two years ago may be tempted to take advantage of this seller’s market. Before you put your home on the market, however, be sure to consider the tax implications. Homeownership and taxes can get complicated depending on how long you’ve owned the property, as well as how much profit you make.
Taxpayer Relief Act of 1997
Your home is considered a capital asset, which means it is subject to capital gains. In many cases, however, you may be exempt thanks to the Taxpayer Relief Act of 1997. Under the Act, single taxpayers do not have to pay capital gains on the sale of a personal residence up to $250,000. That amount increases to $500,000 for married couples filing jointly. To take the exemption, however, you must meet the following:
- Ownership & Use Requirement
During the five years leading up to the date of the sale, you must have owned the home and lived in it for at least two years. There are some exceptions to this eligibility rule, including persons with a disability and military personnel.
- Exemption Timeframe
You may take the exemption once every two years. It is only good for one primary residence, however, even if you meet the ownership requirement for more than one property.
Capital Gains Tax Rates
Depending on how long you owned your home and how much you sell it for, you may be subject to either short-term capital gains tax rates or long-term capital gains tax rates.
Short-Term Capital Gains Tax Rates
If you have owned your home for less than one year, you are ineligible to take the exemption. You will also be subject to short-term capital gains tax rates for any profit made from the sale. The short-term capital gains tax rate is equal to your income tax rate. For example, if you are single and in the 22% tax bracket, you’ll pay 22% in capital gains tax on the sale of your home.
Long-Term Capital Gains Tax Rates
The long-term capital gains tax rate applies if you’ve owned your home for more than a year. Although many people qualify for the 0% tax rate, you may fall into the 15% or 20% bracket depending on your filing status and income.
If you purchased the home within 12 months but less than two years from the sale date, you’ll be required to pay long-term capital gains tax on any profit (sale price minus cost basis). You must also pay taxes on any amount that exceeds the IRS thresholds if you’re eligible for the exemption. For example, a married couple with a combined income of $500,000 and capital gains of $600,000 from the sale of their home would have to pay 20% tax on $100,000, if they qualified for the exemption.
Cost Basis & Capital Gains
Determining how much of your home’s sale price is subject to capital gains tax depends on the cost basis of your home and your exemption amount, if any. The cost basis is the value of your home when you paid for it, including improvements costs, certain legal fees, and other associated expenses. The cost basis of your home, however, can change over time. For example, if you add a room to your home or make significant upgrades to the kitchen, the cost of these projects will increase your cost basis.
Be sure to retain all receipts and invoices for any upgrades made to your home. Unfortunately, improvement costs to maintain your home, or those with a life expectancy of less than a year, do not increase your cost basis.
It is also possible for your cost basis to decrease in value over time. This typically happens when you’ve received an insurance payment due to loss from flood, fire, or other disasters. Although it’s possible to experience a loss when selling your home, especially if your cost basis has decreased, you may not take it as a deduction on your tax return.
When is My Home Not Exempt From Capital Gains Tax?
If you’re looking to make a quick profit by flipping properties, keep in mind that you’re unlikely to be eligible for any capital gains tax exemption. As noted previously, you must own and live at your home for at least two of the five years prior to the sale. You may also be ineligible to receive the exemption if:
- You are subject to expatriation tax.
- You acquired your home in a like-kind exchange (also known as a section 1031 exchange) within the last five years before selling it.
- You’ve taken the exemption for another property within the last two years.
Before deciding to sell your home, be sure you understand the tax consequences and how you can minimize your liability. We highly recommend reviewing Publication 523, Selling Your Home, for help with determining your cost basis, figuring gains and losses, as well as familiarizing yourself with the IRS reporting requirements.