Does it apply to every home seller?
Luckily, no. The IRS is pretty nice when it comes to capital gains on real estate, allowing you to potentially exclude up to $250,000 of gains if you’re single and $500,000 if you’re married and filing jointly. But, hold on. You’re thinking to yourself that you have nothing to worry about, but there’s more.
That exclusion only applies if you meet a certain set of criteria. If any one of the following criteria is true, you’re subject to be taxed on the entire gain.
- You owned the home for less than two years.
- The house sold wasn’t your primary residence for at least two of the last five years that you owned it.
- You’ve already used the $250,000 or $500,000 exclusion on another home in the last two years.
Let’s look at an example. You bought your home in 2018 for $230,000. It turns out you do, for whatever weird reason, want to live as close to your in-laws as possible. You decide to sell it the next year (in the best market ever) for $400,000. The $170,000 that you made would be taxable because you resided there for under two years.
Back to “Basis”
Remember that “basis” we mentioned back in the definition of capital gains tax? Well, here’s where that comes in handy. It’s not just the amount you purchased the home for, but includes a litany of other fees and expenses for your home. If you made any additions or improvements that increased the value of the property (not including ordinary maintenance), those can be counted towards the basis. Maybe you added a deck, a fence for Fido, and did a HGTV number on your kitchen in the year that you lived there. Save your receipts.
Another thing to hang onto is the closing statement you received when you closed on the home. Things like recording fees and other costs can be used towards the adjusted cost basis and help you minimize capital gains tax on a house sale.
Back to our example, you paid $230,000 for the home originally, but you have receipts for $150,000 worth of additions, improvements and costs that increase your basis. Then only $20,000 of your gain would be taxable.
Other Factors
If you’re not sure whether you qualify for the exemption, you can contact a professional, such as a CPA. There are other considerations as well, like if you were forced to move due to illness, work, or an unforeseeable event (Moving in next door to your in-laws probably doesn’t count here) you may be exempt from the tax. If you used a 1031 exchange or are subject to an expatriation tax, it could also change how your capital gains are treated under the tax code.
