A lot of home sellers wonder whether they will need to pay taxes on the profit they make when they sell their home. You should consult with your accountant, or CPA for a full understanding of the tax laws, and their impact on your net profits. For our purposes, we will give you an overview of some tax concepts you should be aware of, so you know what questions to ask.
There are cases where you can avoid paying any capital gains tax on the profits from your home sale:
- How long you owned and lived in the home – if an individual owned and lived in the house for 2 of the last 5 years as their primary residence, then up to $250,000 of gain is tax free. A married couple, filing a joint file return, can exclude up to $500,000 of gain.
- How much profit you made on the sale – if your profit exceeds the $250,000 or $500,000 limit, the excess would be reported as a capital gain, and subject to taxes.
There are some situations where you can still avoid paying capital gains tax, even if you do not meet the above criteria. Some of these considerations can either provide you with a full or partial tax exclusion.
- Divorced – if you were granted ownership of the home as a result of a divorce settlement, you can count the time that your former spouse owned the property for purposes of the 2-5 year requirement.
- Death – if one spouse passed away, and the remaining spouse chose not to stay in the property, they can count the period that the deceased spouse owned and used the home.
- Military service – this applies to any member of the uniformed services, foreign service, and intelligence agencies. Instead of the 2-5 year requirement for ownership and occupancy of the property, it can be extended up to 10 years during any period that you or your spouse serves qualified official extended duty. This only qualifies for more than 90 days (or an indefinite time period) as long as you are:
- At a duty station that’s 50 miles away from your primary residence
- Residing under government orders in government housing
You can only claim full exclusion on taxes once every two years. A reduced exclusion is available for anyone who doesn’t meet the requirements due to:
- Change in employment
- Health concerns, or
- Other unforeseen circumstances (divorce or multiple births from a single pregnancy)
This reduced exclusion means you receive less than the $250,000 or $500,000 exclusion. Although it’s important to remember that you can use this reduced exclusion on any number of times during your life, you are NOT allowed to use it more than once every two years.
HOW TO CALCULATE GAINS ON THE SALE
It makes sense that you expect some sort of gain when you sell your house. For tax purposes, you need to factor in your adjusted cost basis to know whether you gained or lost something in the sale, and how much.
Adjusted basis is the cost of your home adjusted for tax purposes by improvements you’ve made, or deductions you’ve taken. By improvements, we mean anything done that adds value to your property or give it a new or different use. Routine maintenance and minor repairs such as a new paint job are NOT included. Some improvements that qualify are a new roof, remodeled kitchen, remodeled bath, or a new HVAC system. Any depreciation, casualty losses or energy credits that you claimed to reduce your tax bill, while you owned the property, should be deducted from your adjusted basis.
To illustrate this further, let’s say that the original cost of your home stands at $150,000. You remodeled your kitchen, which cost you $20,000. Your adjusted cost basis becomes $170,000. However, you took a $10,000 casualty loss deduction. This makes your final adjusted cost basis $160,000.
It’s always wise to consult with a tax professional with up-to-date information and trends. Remember, tax laws and rules have the tendency to change periodically. The IRS discusses basis and adjusted basis in detail in Publication 551, Basis of Assets.
Taxes can be confusing for both experienced, and first time sellers, and investors. While you’ll want to speak with your accountant, or CPA, our team at SellUsHomes can help guide you in the right direction, and know what questions to ask. Our goal is to make your sale as smooth, and hassle free as possible, so you can maximize your profits. We purchase houses in As-Is condition in Detroit and Southeast Michigan. To learn more about our services, contact us at (734) 224-5947 or reach out to us via email at firstname.lastname@example.org.