In our last blog, we discussed some tax implications of buying a new home. But what happens when it’s time to sell? Let’s look at some common scenarios to see how selling might affect your tax return.
The good news is most taxpayers don’t have a tax consequence from selling their home. If you realize a profit from the sale, you will not owe taxes on the first $250,000 of profit if you’re single ($500,000 if married) as long as you meet a couple of conditions. First, you must have owned and used the house as your primary residence for at least 2 of the previous 5 years. Note that this doesn’t necessarily mean 2 consecutive years, nor does it mean the last 2 of the 5-year period. Second, you cannot have taken this exclusion in the past 2 years. These are generous rules that most homeowners don’t have trouble meeting. Even better, the previous rule that sales proceeds had to be used to purchase a new home in order to avoid taxation no longer applies.
There are some exceptions to these rules for taxpayers who are members of the armed forces and for taxpayers who jointly owned a home that is included in divorce proceedings. Taxpayers who sell a home they’ve owned for less than 2 years may qualify for a partial exclusion if the sale was due to a change in employment, health, or other specified circumstances.
If you don’t meet the requirements to exclude sales proceeds, keep in mind that you are only taxed on any profit earned. This is not simply the amount received from the sale but is instead figured by subtracting the house’s adjusted basis from the sales amount. The adjusted basis is the original purchase price plus certain costs associated with the purchase, the costs of capital improvements, and certain costs associated with selling the property.
If you do not realize a profit, you don’t have to report the sale on your tax return unless you received a form 1099-S, which reports real estate transactions to the IRS. Some real estate professionals have sellers sign a document stating no profit is being made so a 1099-S is not due; others play it safe and issue the forms to all sellers. If you receive a 1099-S you must report it on your return, even if no taxes are due. Unfortunately, if the sale of your home results in a loss, you cannot deduct it.
If the home was a rental or used in business at any point, there are additional tax considerations. The basis of the house should have been reduced annually through depreciation. Whether or not depreciation was actually taken, the amount that was allowable must be recaptured when the property is sold. (If you have a rental and have not been depreciating it, you’re in luck … this is one of the few issues that can be fixed even after the normal 3-year period to amend a return has passed. If you own a rental and haven’t been taking depreciation, talk with us to see how to get this tax break!).
If the rental property does not meet the requirements discussed above (ie. you did not live in it as your primary residence for 2 of the past 5 years) you cannot exclude any gain. This is why it is critical to track all items that can impact a rental’s basis. It’s easy to forget about expenses for improvements if you don’t keep good records. Don’t forget that certain costs associated with purchasing and selling the home figure into its basis. Subtracting the adjusted basis from the sales price leaves you with the amount of capital gains that will be reported on the tax return.
Selling a home can be stressful; don’t let tax issues add to your stress. We’re here to help with the tax issues involved, so give us a call!