Ten Things You Need To Know About Capital Gains Tax
When you sell your property, the IRS may exclude up to $250,000 of your capital gain from your taxes if single, and up to $500,000 if married, and filing a joint tax return. Many homeowners take advantage of this law. Here are the top ten facts every home seller should know about this tax law. (As always, the laws can change, so we recommend you seek tax advice from a tax professional.)
#1: The exclusion only applies to primary homes. Your primary home is the one you live in the majority of the time. If you own and live in more than one property, you can typically nominate one of them as your primary home. However, you can’t be disingenuous to get the tax benefit. The IRS applies certain tests to a transaction in order to make sure the home which you nominate is indeed your primary residence. They consider items such as the location of your home in proximity to where you work, where other family members spend the majority of their time, and the location where you are registered to vote.
#2: To claim the exemption, you must live in the home for at least two out of the last five years before you sell. The 24 months do not have to be concurrent. For example, you could live in the property for 18 months, move out for a year, then move back in for an additional six months prior to the sale – and still claim the home sale exclusion.
#3: You must own the home for at least two out of the past five years. The same test applies.
#4: The ownership and residency tests don’t apply in “unforeseen circumstances.” Unforeseen circumstances are unpredictable events that happen typically with short notice and may affect your ability to remain in your home. Some examples may be serious health issues, divorce, a family death – or a job relocation that requires moving more than 50 miles away from your primary residence. If you experience any of these events, you may still be able to claim the home sale exclusion – even if you sell your home before the two-year qualifying period is up. Again, check with a tax professional to determine your appropriate measures for filing, as well as current tax laws.
#5: Your maximum deduction may be less than $250,000. Most homeowners can deduct all of their gains up to $250,000. However, homeowners who claim an unforeseen circumstances exclusion can likely only make a partial deduction based on their occupancy. A homeowner who lives in the house for the full two years before a home sale can currently deduct the first $250,000 of profit from their taxable income. A homeowner who gets divorced and moves out after just six months can typically claim one-fourth of that amount (or $62,500), currently.
#6: Married couples who file joint returns can deduct up to $500,000 of gain. Both spouses must live in the property for at least two out of the five years immediately preceding the sale. They do not, however, have to co-own the property — only one spouse needs to meet the two-out-of-the-last-five-years ownership test.
#7: There’s currently no limit on the number of times you can use the tax break. The main residence tax exclusion is not a one-time tax benefit. Qualifying homeowners can buy a home, live in it for two years, sell the home, and exclude the capital gain– then repeat the process. You can keep repeating the process as many times as you please.
#8: Your gain might be lower than you think. Many of the expenses you incur in selling your home and also on improving it over the course of your ownership can be deducted (in whole or perhaps in part) from the sales price in order to reduce your net taxable gain. For example, you can deduct appraisal fees, advertising fees, escrow fees, notary fees, broker’s commission, title search fees, and other closing costs. You can also deduct the cost of capital improvements such as adding a new kitchen, upgrading the heating system, or fitting a wall-to-wall carpet. Regular home repairs that simply keep your property in operating condition (maintenance items such as fixing broken gutters, etc.) can’t be deducted. These deductions can make a large (positive) impact on your tax bill.
#9: In most cases, you don’t have to report the gain. Home sellers who can exclude their gain don’t need to report the home sale to the IRS. However, you must report the gain if you can exclude only part of the home – or if the IRS sends you an informational income reporting document such as form 1099-S.
#10: Home sale losses are not tax deductible. Tax law does not allow taxpayers to deduct a home sale loss from their taxable income. The exclusion applies only to capital gains.