Tag: Capital Gains Exemption

What Are the Capital Gains Tax Implications of Selling Your Primary Residence?

Prior to 1988, you had to reinvest the profits from selling your home into a new home, but that is no longer the case. As long as you have lived in your primary home for two of the last five years at the time of sale, you are exempt from taxation on your capital gain up to $250,000 (single) or $500,000 (married).

If your spouse dies, you can still get the $500,000 exemption if you sell less than two years after his or her death.

In calculating your capital gain, you take the price of the home when purchased plus any capital improvements (not repairs) made to the home plus the cost of selling (commissions, title insurance, etc.) and subtract that from your selling price. Note: this is my layman’s understanding. Always consult a qualified tax advisor to see how these rules apply in your situation.

Here is a lengthier explanation of the above rules plus some I didn’t mention — sorry I didn’t make note of the source:

The capital gains exclusion for selling one’s primary residence is a tax benefit in the United States that allows homeowners to exclude from their income a portion or all of the capital gain they realize from the sale of their main home, under certain conditions.

  1. Exclusion Amount: Single taxpayers can exclude up to $250,000 of capital gains on the sale of their primary residence, and married taxpayers who file jointly can exclude up to $500,000.
  2. Ownership and Use Test: To qualify for the exclusion, you must have owned the home and used it as your primary residence for at least two of the five years prior to the date of sale. These two years of residency do not need to be consecutive.
  3. Frequency of Exclusion: The exclusion can only be claimed once every two years. That is, you cannot claim the exclusion if you’ve already claimed it on a different home in the two-year period before the sale of the current home.
  4. Partial Exclusion: If you do not meet the Ownership and Use Test fully, you might still be eligible for a partial exclusion if your home sale was due to a change in employment, health reasons, or other unforeseen circumstances specified by the IRS.
  5. Reporting: If the gain on the sale is entirely covered by the exclusion, in many cases you do not even need to report the sale on your income tax return.
  6. Deceased Spouse: If a spouse is deceased, the surviving spouse may still qualify for the $500,000 exclusion under certain circumstances, generally within two years of the spouse’s death.

Remember that tax laws are complex and can change, and individual circumstances can have a significant impact on tax obligations. It’s important to consult with a tax advisor or accountant to understand the potential tax implications of a home sale.

Many Home Sellers Aren’t Familiar With the Capital Gains Tax Exemption

I’m not an accountant or tax advisor, but periodically I need to explain to clients the exemption on capital gains tax enjoyed by homeowners. (You’ll want to verify what I write with your accountant or tax advisor.)

Prior to 1997, the seller of one’s primary residence was required to buy another home that was at least as costly as their previous home in order to avoid paying capital gains tax on the sale.  Since passage of the Taxpayer Relief Act of 1997, however, that is no longer the case, although there are several important rules.

First of all, the home you sell must have been your primary residence for two of the five years preceding the date of sale, and you can only do this once every two years. 

Rita and I once sold a home after owning and living in it for just 18 months, but there was no gain on the sale, so it didn’t matter that we didn’t qualify for the exemption.

Occupancy does not have to be continuous. You only have to have lived in the house for a total of 24 months prior to the date of sale. If you want to enjoy the exemption on a home that you previously lived in, then rented for less than five years, you may need to move into it until the total occupancy meets the 2-year requirement, if you want to enjoy the exemption.

If you’re single, you are exempt from tax on the first $250,000 of gain. For a married couple, the exemption is doubled. (For LGBT couples who own a home together, being able to marry legally brought with it this significant financial advantage.) The gain is calculated by deducting from the sale price your “basis” in the home.  That basis is the sum of the price you paid for the home, the cost of improvements or additions made to it, and the costs and fees associated with purchasing and selling it. Those fees include real estate commissions, title insurance, recording fees, legal expenses, etc.

For example, let’s say you bought a home 30 years ago for $100,000 and you sell it for $700,000 this year. You are married, so you qualify for the $500,000 exemption. If you can document $50,000 in improvements (not repairs), and your cost of selling was, say, 6%, including commissions, title insurance and fees, your basis is increased by $92,000, raising it to $192,000. Thus, your gain was $508,000, but only $8,000 of it is taxable. You will owe 15% federal plus 4.5% Colorado capital gains tax on that $8,000. That amounts to $1,560 tax that would be due the following April 15. That still leaves a lot of tax-free profit from the sale!

Now and then, I meet a couple, like I did last week, who are selling a home they purchased over 30 years ago, and are pushing up against a capital gains tax liability, especially if the homeowner is not married. (If the homeowner is widowed, he or she has two years to sell before the exemption drops to $250,000.) If you are in that situation or approaching it, you could benefit from selling your home and buying another one.

It’s a mistake to put your heirs on the title of your home so they inherit it. That’s because in addition to inheriting your home, they also inherit your basis, which could cost them dearly when they end up selling it.  It’s better to put them on a “beneficiary deed” or let them inherit it through your will. In either scenario, the basis of the home is stepped up to its market value at the time of your death.  The beneficiary deed is a particularly attractive option because the cost of creating and recording it is minimal, and it can be revoked at any time.

One of my clients is a home builder. He builds homes one at a time over a 2-year period, moving into and living in each of them for two years while building the next house. That way he is able to apply the full $500,000 marital exemption to the sale of each house, whereas he’d owe regular income tax on his profit for each home if he sold it upon completion.

You can claim the exemption on the sale of a second home, but you need to have lived in it as your primary residence for two of five years preceding the date of sale, and, as mentioned above, you have to wait two years before taking that exemption on your other home.

If you have additional questions about qualifying for this tax exemption, don’t ask me. As I said, I’m not an accountant or tax advisor.  However, I can refer you to our accountant (who does our taxes) if you don’t have one. I can also refer you to a real estate lawyer for a beneficiary deed.