Taxpayers (like me) appreciate the capital gains exemption on the sale of one’s primary residence, but not everyone is familiar with how it works. A single person enjoys a $250,000 exemption and married couples (filing jointly) enjoy a $500,000 exemption on the profit they make on the sale of their home, providing they have owned and occupied it for two of the five years preceding its date of sale.
Given the runaway appreciation of homes that you and I have seen in 2020 and 2021, more homeowners are thinking of “cashing out” and wondering how much capital gains tax they may have to pay on the sale of their home.
The exemption applies to the gain over your home’s “basis,” not to the sales price. That basis begins with what you paid for your home but is increased by the amount of any improvements you have made to the home as well as the cost of selling it.
Thus, if you paid $200,000 for your home but you made, say, $50,000 in improvements (not repairs), your basis jumps to $250,000. Then add the cost of selling your home (commissions plus title insurance and other closing costs), which should amount to 5 or 6% of the sales price. If you sell your house for, say, $500,000, your basis would be increased by another $25-30,000.
Because your gain, in that example, would be under $250,000, your entire proceeds on the sale of your home would be tax-free, whether you’re single or married. For many sellers, however, the taxable gain could be well in excess of $250,000 or even $500,000.
If your spouse died less than two years prior to the closing and you haven’t remarried, you can still enjoy the full $500,000 tax exemption. Also, your basis is “stepped up” for your spouse’s half of the home, whether or not you owned your home as “joint tenants.”
Also, if you were deployed at least 50 miles from your home, you can pause the 2-out-of-the-last-5-years rule by up to 10 years.
As with any IRS rule, it’s complicated, so you’ll want to visit www.irs.gov/publications/p523 to read IRS Publication 523. Reading it will be worth your time.