Tax implications of selling your home

Exclusion of Gains on Home Sale

Before any large financial decision, you should ask yourself “What are the tax implications of this?” Failing to consider the tax impact on some decisions can lead to an unpleasant surprise come tax season. Fortunately, the sale of your personal home is a financial event where you can generally expect favorable tax treatment. That is because the tax code allows you to exclude up to $500,000 in capital gains when selling your primary residence, provided you meet certain requirements.

So what are capital gains? Capital gains are any profits from selling personal property above the original purchase price. If you purchase a painting for $10,000 and later sell it for $15,000 you have capital gains of $5,000, which can be taxed at rates up to 20%. However, when you sell your primary residence you can avoid the capital gains tax on the sale if you meet the following three requirements:

  1. Ownership Test: You need to have owned the home for at least 24 months out of the last 5 years leading up to the date of the sale. If you are married, only one spouse needs to own the property.

  2. Residence Test: You must have used the property as your primary residence for at least 24 months out of the last 5 years. These 24 months are not required to be consecutive. If you are married each spouse must meet this test to qualify for the full exclusion.

  3. Lookback Test: You cannot have taken the exclusion for the sale of another property in the last 2 years.

If you meet these three requirements, then you can exclude up to $250,000 ($500,000 if married and filing a joint return) in capital gains from the sale of your home. If you have capital gains in excess of the exclusion amount you will be required to pay taxes on the excess amount.

Partial Exclusion

If you do not meet the above requirements you may still be eligible for a partial exclusion if you sold the house for one of the following reasons:

  • Work-Related Move: If you or your spouse get a job that is at least 50 miles further from your house than your previous job you can qualify for the partial exemption.

  • Health-Related Move: If you move to obtain medical treatment for yourself or a family member, or to provide medical or personal care for a family member suffering from a disease or injury.

  • Unforeseeable Events: You or your spouse:

    • Dies

    • Gets divorced or legally separated

    • Gives birth to two or more children from the same pregnancy

    • Becomes eligible for unemployment compensation

    • Becomes unable to pay basic living expenses for the household due to a change in employment status.

If one of these special circumstances applies to you then you can receive a partial exemption based on the percentage of the 2-year residence requirement that you meet.

Example: One year after purchasing your home, you or your spouse gives birth to twins and you decide to sell your home to find a larger home. Even though you do not meet the 2-year ownership and residence requirements, you can receive a partial exclusion of the capital gains since the move was due to the birth of twins. In this case your exclusion would be one half of $500,000 since you resided in the house for 1 of the 2 required years. 

Summary

Our homes are one of the few assets that we own that have the potential to appreciate. If you own your home and live in it for more than 2 years before you sell it, you can exclude up to $500,000 of the gains from your taxable income. If you do not meet the 2-year requirement you may still be eligible for a partial exclusion if one of the provided special circumstances applies to you.

 

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