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Whether you need to relocate, want a bigger or smaller space, or feel it makes financial sense, selling your home is a big decision. It can also have significant tax consequences.
Here are three ways selling your home can impact your tax liability:
1. Realized gain
Realized gain is the profit you make from selling an asset, such as your home — and it can be taxable. According to the IRS, the basic formula for calculating realized gain is as follows:
Selling price – Selling expenses – Adjusted basis = Realized gain
This means you need to calculate two things to find your realized gain on the sale of your home: your selling expenses and basis. It might sound simple, but both take into account factors that you might not have considered. And calculating them properly could mean a difference of thousands of dollars in your tax liability.
Your selling expenses include any closing costs, real estate commissions, and other related costs that you paid. Comb through your closing documents to make sure you’ve accounted for everything. Don’t include city and county property tax, but do include transfer taxes, if applicable.
Basis includes the original purchase price of your house, plus fees you incurred during home closing, such as title insurance, legal and recording fees, or survey fees. Basis also includes the cost of any major improvements, renovations or system replacements you’ve made. The IRS makes a clear distinction between repairs that are a normal part of home maintenance — such as repairing leaks — and improvements, such as replacing the plumbing system.
For a more comprehensive list of what can and cannot be included in your calculations or selling expenses or basis, refer to IRS Publication 523, “Selling Your Home.”
2. Long vs. short-term capital gain
If you have a realized gain on the sale of your home, it will be subject to a capital gains tax. Whether it’s considered a long- or short-term capital gain depends on how long you’ve owned your home.
If you owned your home for at least a year and a day, any gains you made on its sale will be taxed at long-term capital gains rates, which range from 0% to 23.8%. Otherwise, they’ll be taxed at short-term capital gains rates, which are the same as ordinary income rates. Long-term capital gains rates are based upon a taxpayer’s marginal tax bracket, but are more favorable. For example, a taxpayer in the 15% tax bracket will pay 0% on a long-term capital gain.
If you’re considering selling your home within a year of purchase and project a profit, consider whether you can sell it in a manner that qualifies the sale as a long-term gain. However, if you’re selling your principal residence for a loss, you are not allowed to claim a capital loss — which would reduce your tax bill.
Under Section 121, the IRS allows taxpayers to exclude the first $250,000 of capital gains on the sale of their primary residence if they meet certain ownership and use requirements. Married couples filing jointly can exclude up to $500,000.
If you owned the home for at least two of the five years leading up to the sale, you meet the ownership requirement. If the home was your primary residence for at least 730 days of the previous five years, you meet the use requirements.
If you’re married filing jointly, you must each meet the use requirement to qualify for the $500,000 exclusion. You can still qualify if only one person meets the ownership requirement. And if you’re not married, but selling the house with someone else, you may each take the $250,000 exclusion as long as each of you meets the use requirement, and at least one of you meets the ownership requirement.
The IRS allows partial exclusions for those who don’t meet the requirements, but are selling a home due to work or health-related moves, or unforeseeable events such as death, divorce, natural disaster, unemployment or other qualifying reasons. IRS Publication 523 contains more details.
These tax considerations are important, but reading about them is by no means an adequate substitute for unbiased advice, based on your personal situation. Before you make any major decisions about your home sale, sit down with a fee-only financial planner. He or she can take into account all of the factors that will affect your decision. Having a relationship with a trusted professional is the best way to put together a plan that achieves your financial goals.
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