Tax Planning for Life
Tax Planning for Life-Changing Events: Selling Your Home
Is a Home Sale Always Tax Free?
Most home sales are tax free, but there are some situations where you may have to pay some income taxes on the gain. Before you get too worried, let’s look at the exemption rules.
You can exclude up to $250,000 of gain on the sale of your main home if you’re single or $500,000 of gain if you file a joint tax return. To qualify for the maximum exclusion, you must meet the following requirements:
- Home must be your primary residence (not vacation home, parents’ home you own, rental property, etc.)
- You must have owned and used the residence as your main home for a total of at least two out of the five years prior to the date of sale
- You are generally not eligible for the exclusion if you excluded the gain from another home within the last two years
There are also some specific exemptions in the case of divorce. You and your former spouse can each exclude up to $250,000 of gain on your individual tax returns if you meet the above requirements and jointly sell the home; however, if one spouse receives the home as part of a divorce settlement and subsequently sells the home at a later date, they can only exclude up to $250,000 of gain.
“What if I Don’t Meet the Exclusion Rules?”
If you cannot exclude a gain based on the above rules, it is recommended that you do what you can to minimize the taxes relating to the home sale.
- How do I calculate my gain? Use the following formula to calculate the gain on the sale of your home:
Net Sales Proceeds – Adjusted Tax Basis = Gain or Loss on Home
Your Net Sales Proceeds are the sale price of the home, less certain selling expenses (i.e. real estate commissions, settlement fees, special assessments, and deed registration).
Your Adjusted Tax Basis in the home is equal to the original cost of the home plus any capital improvements that you have made (i.e. remodeling costs, a new roof, driveway or installation of a swimming pool). If you calculate a loss, you cannot deduct the loss on your tax return but you then do not have any income taxes to worry about.
Example: You purchased a home last year for $200,000 and added a swimming pool at a cost of $10,000. Your adjusted tax basis in the home is now $210,000. You sell the home in 2016 for net sales proceeds of $290,000, which is $300,000 less commission costs of $10,000. The net gain on the sale of your home is $80,000 ($290,000 – $210,000).
- Partial exclusion – A reduced exclusion amount is available for certain individuals that do not qualify for the maximum exclusion. In such cases, the sale of your main residence must be due to one of the following reasons:
- A change in place of employment
- Unforeseen circumstances
In this situation, consult a qualified advisor, as the calculation can be complicated.