Tax Breaks When Selling Your Home
One of the best ways to earn money tax-free is by making a profit on the sale of your house. Unlike other investments, you don’t have to pay capital gains tax on home sales, provided you meet certain qualifications. Most importantly, the profit you make from your home sale cannot exceed $250,000 if you’re single or $500,000 if you’re married. If your profit exceeds the allowed limits, you will have to pay tax on the excess at your normal capital gains rate. Unfortunately, you can’t deduct a capital loss as a result of a home sale unless you used the house for business or
In the past, home sellers could take a tax-free home sale profit of up to $125,000 only once in their lifetime. Now, you can take advantage of this exclusion every time you sell a home. Another change to the rule is that you no longer have to spend your home sale profit on a new home; you can spend the profit however you’d like and still not owe capital gains tax.
In order to avoid tax on the sale of a house, you must meet certain requirements. First, you must pass the ownership and use tests. This means that you must be able to prove that you both owned and occupied the house for at least two of the previous five years. Your occupancy need not coincide with your ownership, however. For example, if you rented a house for two years before purchasing it, those two years still count toward your use test, assuming you sell the house within five years of moving out. The two years required for the use test also need not be consecutive; as long as you used the house as your primary residency for at least 24 months within the past five years, you pass the use test.
For a married couple attempting to exclude up to $500,000 in profit, both parties must pass the use test, but only one needs to pass the ownership test. You also must be legally married and file a joint tax return that year. Additionally, neither of you can claim the exclusion if you’ve already done so within the past two years. This means that if one or both of you sold a house two years ago without paying sales tax on the profit, you cannot sell another house without facing taxes on the gain.
To determine if your gain is below the $250,000 or $500,000 limit, you’ll have to calculate your basis. This number is more than just the purchase price of the home. You must also consider the costs associated with buying and selling the house (realtor commission, title fees, etc.) and any home improvements you made. You can also subtract any depreciation, such as using the house as a home office.
For example, let’s say you purchased a house for $150,000, paid an additional $5,000 in closing costs when you bought it, and put $25,000 worth of improvements into it. You then sell it for $450,000, which includes all closing costs. Your basis becomes $180,000 (purchase price, purchase costs, home improvements), and your net profit is $270,000. If you’re single, you owe tax on $20,000 of the profit. If you’re married, you owe nothing. As you can see, a higher cost basis makes you less likely to owe taxes, which is why depreciating for a home office is an attractive option.
Calculating Basis and Taxable Gain
Purchase price + Purchase cost + Home improvements + Selling costs - Depreciation
Sale price - Basis = Gain (or loss)
Gain- Exclusion =Taxable gain
If you receive a home as an inheritance or a gift, your starting basis is the fair market value at the point you inherited it, not your benefactor’s basis. This rule makes it easy for a beneficiary to sell an inherited house without facing a large tax bill.
Sometimes a homeowner is forced to sell a house because of a job-related move, health concerns or unforeseen circumstances. If this happens before the homeowner has owned and/or occupied the house for the full two years, he or she may be able to exclude a portion of the gain.
To exclude taxes on a vacation or rental home, you can make it your primary residence for two years before attempting to sell. This may be a good option for you if your second home has substantially appreciated since you purchased it.
If your home has severely depreciated, you can deduct a loss only if you first convert it to a rental property before you sell it. However, when you do so your basis will become the lesser of the property’s fair market value or its tax basis, so your deduction may be limited.
Despite this generous tax break, some homeowners will end up owing taxes on home sale gains. If you do, you can report the gain on Schedule D, along with other capital gains. If you sell the house within a year of buying it, report your profit as a short-term capital gain. Otherwise, it’s considered a long-term gain.
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