The purchase of your home is likely the biggest purchase you have ever made. The time can energy you put into searching, touring, negotiating, inspecting, and, finally, closing to them arrive as owning your home is a huge accomplishment. Now, you are ready to move on and sell. So what do you need to consider?
When the housing market is hot, many buyers and sellers have made big decisions when it comes to their property. Many that have been able to sell their home likely made a profit, but for some, that may mean there will be tax consequences to consider.
Keep reading to understand how the profits from your home sale may have hidden tax implications.
Did you know that your home is considered a capital asset, which is subject to capital gains tax? Therefore, if the value of your home has appreciated in the time you lived there, you may have to pay taxes on the profit you make. However, most homeowners are exempt due to the Taxpayer Relief Act of 1997.
To quality, you must meet the following requirements:
Also known as a principal residence, your primary residence is your home. It doesn’t matter if it is a house, condo, or townhome; if you reside there most of the year and can prove it, it is considered your primary residence.
Rules of primary residence
If you happen to own and live in more than one home, the IRS establishes your primary residence by:
As you can see, these requirements are relatively simple, however, it can get more complicated for a homeowner who has multiple homes.
It is important to note that this rule comes more into play for those individuals with more than one property in which they spend significant time. The use test often causes confusion. Simply put, if you lived in a home for a total of two years, or 730 days during the previous five years, that can count as your primary residence. The 24-month period does not have to be concurrent or fall into a specific block of time. However, the one caveat for married filing jointly couples, each partner must meet the rule.
If you have only had the property for less than a year and you sell, you would face short-term capital gains rates. Unfortunately, these are generally the same as the ordinary income tax rates, which are more significant than long-term capital gains rates.
On the flip side are the homeowners who have owned their home for many years and could be selling it for a significant profit. As a result, they may exceed the maximum profit exemption amount on their primary residence. Those gains would be taxed at the long-term capital gains rate, depending on what tax bracket they fall into.
Suppose you bought a home eight years ago for $250,000 and sold it today for $850,000. You would make $600,000. If you are married and filing jointly, $500,000 of that gain may not be subject to the capital gains tax, but the $100,000 gain could be.
Determining the cost basis of one’s home can create some confusion. Many home sellers make an assumption that the cost basis is the difference between how much your own on the house and for what you sold it. In fact, the basis of a home is what the gain is calculated from, not the loan.
The basis is actually the original purchase price, plus closing costs (realtor fees, origination fees, title insurance, etc.). All of these numbers can be found on your purchase closing statement.
In a hot seller’s market, this amount can be considerable.
Any improvement made to the home, such as bathroom remodels, kitchen renovations, roof replacement, or adding a garage or porch, can increase your basis. But that isn’t the only way to calculate cost basis, be sure not to forget any cost associated with staging your home.
Suppose a married filing jointly couple bought a primary residence five years ago for $300,000 and made $100,000 in improvements. They then sold the home for $850,000. That would result in a $450,000 non-taxable gain (if the sale meets the requirement of all exemptions) since it is under the $500,000 maximum.
It is always a safe bet to ask your tax professional or financial planner if you are unclear about something qualifying as a home improvement.
Organization is the key for individuals reporting the sale of their primary residence.
1. Live in your home for at least two years. Remember, the two years do not have to be consecutive. However, house flippers should beware. If you happen to sell a home that you did not reside in for a minimum of two years, the gains can be taxable. As indicated above, selling a home in less than a year can be especially expensive because you can be subject to short-term capital gain tax, which is generally greater than long-term capital gains tax.2. Inquire whether your qualify for an exception. You might be eligible for some exemption on the taxable gain on the sale of your home if you were forced to sell your home because of work, health, or an unforeseeable event. Review IRS Publication 523 for more information
3. Save the receipts for your home improvements. The cost basis of your home is what you paid to purchase it. Fortunately, it also includes improvements you made to it when you lived there and potential any expenses you have incurred to stage it to sell. When your cost basis is higher, your exposure to capital gains tax is often lower. Expansions, remodels, renovations, new windows, landscaping, and an HVAC systems installation – are all examples of items that may reduce your capital gains tax.
Other state and sales taxes will depend on the state in which the property is located. Individual states have various tax laws that may affect sales tax, including mortgage interest deduction, capital improvements, or energy-saving purchases.
No matter how far in the future it may be, it is crucial to keep your home improvement records and receipts. Save everything – receipts, expenses, invoices – related to improvements or upgrades to your home in a file.
In addition, it may be beneficial to speak with your financial planning and accountant before putting your home on the market to ensure you fully comprehend the implications of selling the property given your unique circumstances (when you brought it, how long you have lived in it, how much you bought it for)
There are a few critical things to keep in mind when it comes to the tax implications of selling your primary residence.
1. Your filing status. Are you filing as single or married filing jointly? This designation can determine how much of your profit will be exempt from taxes.
2. Stay organized. Retain a record of any home improvement you have paid for, as it may help you lower your tax liability if you end up having one.
3. Seek guidance from experts. It can be helpful to speak to an accountant or financial advisor for personalized help to fully understand your tax liability after you sell your home.
If you are contemplating the sale of your home and have questions about your specific situation, please connect with one of our financial planners. Our team is here to guide you and offer assistance.
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The team at Spaugh Dameron Tenny works to present timely educational content that benefits doctors and their unique financial situations.
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