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Taxes On Selling A House – Avoid Taxes On Capital Gains

Taxes On Selling A House – Avoid Taxes On Capital Gains

Though most of the profits you will see from a home-sale are now tax-free, there are still actions you can take to maximize the tax advantages of selling your house. Find out how to calculate your gain, considering your basis, house enhancements and hopefully avoid some of your taxes on selling a house.

It is always a great feeling to make a profit on the sale of your house, however, beware: The Internal Revenue Service might be looking for their piece of the action. This tax that they are looking for is called the capital gains tax. Here’s how you can lessen and even prevent a tax bite on the sale of your home.

Until 1997, once you turned 55, you had the one-time choice of excluding up to $125,000 of gain on the sale of your house. Now, anybody, no matter how old, can omit as much as $250,000 of gain or $500,000 for a couple filing collectively on the sale of a house. As a result, many people will pay no tax unless they have actually lived there for less than 2 out of the last 5 years.

There are two types of capital gains tax, short-term and long-term.

Short-term capital gains tax rates apply if you have only had ownership of the property for less than one year. The rate is the same as your normal income tax rate, also known as your tax bracket.

Long-term capital gains tax rates apply if you have owned the property for more than one year. The tax rates here are much less significant; in fact, many people receive a 0% tax rate. Everybody else pays either 15% or 20%.

The Internal Revenue Service, as well as state boards, calculate capital gains taxes based on the difference of what you’ve paid for a property, your basis, and what you sell it for. Capital gains taxes apply to financial investments, such as stocks or bonds, as well as physical assets like boats, homes, and commercial land.

When it comes to real estate and capital gains taxes, the IRS allows you to exclude up to $250,000 if you’re single, and $500,000 of capital gains on real estate if you file jointly with a spouse.

taxes on selling a house

For example, if you bought a condo 15 years ago for $300,000 and sold it today for $1,000,000, you would have a total profit of $700,000. If you are married and filing jointly, $500,000 of that overall gain might not be subject to the capital gains tax, and $200,000 of the gain could be.

There are, however, a number of factors that can put these attractive exclusions at risk.

  1. If the property wasn’t your primary residence
  2. If you owned the house for less than two years in the five-year period before you sold it.
  3. If you didn’t live in the house for at least two years in the five-year period before you sold it.
  4. If you have already claimed the $250,000 or $500,000 exclusion on another home in the two-year period before the sale of this home.
  5. If you purchased the house through a like-kind exchange
  6. You are subject to expatriate tax.

How To Avoid Capital Gains Tax On A Home Sale

So the one thing everyone wants to know is how you can avoid taxes on selling a house. While it is not all that difficult to avoid capital gains taxes when selling a home, there are a few things that you can do to ensure your tax exclusion.

Live In The House For At Least Two Years

To start, you can simply live in the house for two or more years to qualify for the tax exclusion. The two years do not need to be one after the other, meaning you could live in the house for one year, rent for a couple years, then move back in for a second year and qualify for the exclusion.

taxes on selling a house

House-flippers should be aware of these rules as the taxes on selling a house can be considerable. If you sell a house for a profit and you didn’t live in the house for at least two years, the gains would then likely be taxable. Selling in such a short time is also especially expensive because you would likely b subject to the short-term capital gains tax, which is higher than long-term capital gains tax.

Keep The Receipts For Your Home Enhancements & Home Improvements

When calculating the cost basis for your home, you should not only include the amount paid for the home when purchased, but also the costs for all of the enhancements you make to the house as well as improvements to the house. This includes things like home remodeling, home expansions, adding hurricane windows, costs for things like landscaping, pools, fencing, air conditioning and much more. All of these things add to your cost basis and ultimately lessen your exposure to the capital gains tax.

Calculating The Gains On The Sale Of A Home

If you sell your house for more money than you originally paid for it, then you have made a profit. If you have profited from any investment, you are potentially liable for capital gains taxes.  If you are not sure whether or not you have made a profit in the sale of your home, you need to first find out your adjusted basis. This will be the starting point to understand your liability for taxes on selling a house.

The adjusted basis covers what you’ve invested in the home. This includes what you originally paid for the house, as well as the cost of any improvements you’ve made to the house. Capital improvements are ones that add value to your home or give it a new or different use. However, expenses for things like general maintenance and repairs, are not included. You also need to subtract any home depreciation, casualty losses or energy credits you are entitled to.

Calculating The Original Cost Of The Home

For most people, this will be an easy number to find. In short, this includes the amount that you paid for your home at the time of purchase, in addition to any closing costs and settlement costs. If you’ve built the house yourself, the cost of the home is based on the cost of the land, the construction costs, all of the fees you paid to vendors like contractors, subcontractors, and architects. Once you have the original cost, you can then begin to calculate your expected taxes on selling a house.

What is the adjusted basis of my home?

The adjusted basis is the cost of your home adjusted for tax purposes by home improvements made to the house or previous deductions are taken. For example, if the home originally cost $500,000 and you added a $5,000 patio, your adjusted basis becomes $505,000. If you then took a $5,000 casualty loss deduction, your adjusted basis becomes $500,000.

The result of all these calculations is the adjusted basis that you can then subtract from the selling price of your house to understand if you’ve made a profit or not.

Basis When You Inherit A Home

If you have inherited your home, the basis will usually just be the fair market value of the home at the time of your spouse’s death.  In the situation that you lived in a state that was not a community property state, your basis for the inherited portion of the home will be the fair market value at your spouse’s death multiplied by the percentage of the home your spouse owned. When you inherit a home from someone other than a spouse, your basis will generally be the fair market value of the home at the time of the owner’s death. Your basis generally is the same as the person you inherited the property from.

Home Offices Are A Tax Drawback

The exclusion for taxes on selling a home do not apply to depreciation allowable on residences after May 6, 1997. If you are in a higher tax bracket and you are intending on staying in your house for a long period of time, then taking depreciation deductions for a home office can be a very positive thing. If you don’t plan to stay for a long time though, you may want to reconsider a home office deduction. This is because depreciation deductions are taxed at 25% when you sell the house.

Splitting Up Big Profits

If you are anticipating big profits when you sell your house, you should think about ways to divide ownership of the home. For example, if a couple gives a share of their home to their adult son, and the son meets the use tests for capital gains tax exclusion, the son may sell his share for a $250,000 gain without incurring any taxes. His parents could now sell their share of the house for a $500,000 without incurring any taxes, which would shelter the entire $750,000 gain.

Frequently Asked Questions About Taxes On Selling A House

Do I Have To Pay Taxes On The Profit I Made Selling My Home?

A number of factors go into whether or not the capital gains tax applies to you. For one, it depends on the length of time that you have owned the home and lived in the home before the sale is important. If you owned and lived in the place for two of the five years before the sale, then you can retain up to $250,000 of the profit without paying capital gains tax.  If you are married and filing jointly, you qualify for up to a $500,000 exclusion.

How Do I Get A Tax Break On Capital Gains Tax?

If you are hoping to avoid the taxes on selling a house, there are three main factors that come in to play:

  • Ownership: You have to own the home for at least two years. The exact timeframe is actually 730 days or 24 full months. This two years must have taken place during the five years prior to the date of your sale. The two years do not have to be continuous, nor do they have to be the two years immediately before the sale. For example, if you raised a family in a home as your primary residence, then rented the home for two years before selling, you would still qualify for an exemption from taxes on selling a house.
  • Use: In order to qualify for the capital gains tax exemption, you have to have used the home you are selling as your principal residence for at least two of the five years prior to the date of sale.
  • Timing: In order to qualify for an exemption on taxes on selling a house, you must not have excluded the gain on the sale of another home within two years prior to this sale.

Are There Any Special Circumstances To Avoid Taxes on Selling A Home?

If you don’t meet the above requirements to avoid capital gains taxes on selling a house, there are some additional rules that apply to people with special circumstances that allow you to still get the full exclusion or a partial exclusion.

  • If you receive the house as a result of a divorce, you can count the time your former partner owned the house as the time you owned the house.
  • You can count short absences from the house as time lived in the home. This even applies if you rented the home to others during these times.
  • If a spouse dies and the surviving spouse has not remarried prior to selling the house, the surviving spouse can count the period the deceased spouse owned and used the property toward the ownership-and-use test.

Do I Have To Report The Home Sale On My Tax Return?

If you do not meet the requirements to exclude the capital gains taxes on the sale of your home, then yes, you need to report the sale of your home on your tax return. If you do have to pay taxes on selling your house, you will need to fill out form 1099-S.

Form 1099-S covers Proceeds from Real Estate Transactions. This form is typically given to you by the real estate closing agent, real estate brokerage, the title company, or the broker or mortgage lender.

The IRS does not require the real estate agent who closes the deal to use Form 1099-S to report a home sale amounting to $250,000 or less ($500,000 or less for married couples filing jointly).