Tax Implications of Selling a Home
Buying a home is generally the largest purchase of a person's lifetime. Likewise, selling a home is usually a person's largest sale. Often there is an increase in the home's value between the time it is purchased and later sold. Fortunately, the home sale tax exclusion provides favorable treatment for qualifying taxpayers selling their homes.
When preparing to sell your home, use the following to help determine if you qualify for the home sale exclusion:
- If married and filing jointly. Married taxpayers filing jointly may exclude up to $500,000 from capital gains taxes. Single taxpayers and taxpayers that are married but filing separately may exclude $250,000.
- Calculate more than the purchase price and the sale price. Taxpayers should first figure out the adjusted basis of the house. The adjusted basis is the purchase price plus any improvements made to the house. If the taxpayer installed a new $20,000 kitchen and added $40,000 addition to the house, then the adjusted basis would be the purchase price plus $60,000. In addition, costs for selling the house would be included in the adjusted basis, so payment to the real estate broker would give the seller of a home a tax advantage. It is important to remember that repairs and maintenance, however, are not part of the adjusted basis. Fixing pipes, painting the garage, and repairing broken windows do not add to the adjusted basis of the house. However, repairs done as part of a house remodeling do count toward the adjusted basis.
- Establish principal residence. To qualify for the principal residence exception, a home must have been the taxpayer's principal residence during two of the past five years. Long absences from a house may jeopardize a taxpayer's ability to utilize the principal residence exception. Note that use of a vacation home during the summer would not interfere with a home sale tax exclusion, but taking a sabbatical in a foreign country or renting the property before selling it might. A person who uses multiple residences may not have more than one principal residence. The exclusion can only be claimed if it has not been previously been claimed by the taxpayers in the last two years.
- Keep or retrieve records. To properly calculate the adjusted basis of a house, a taxpayer should keep meticulous records of improvements. This means that a taxpayer should hold onto receipts of all improvements to the house, in addition to a contract for the original purchase of the house.
The capital gains from the sale of a primary residence can be very large. Without the exclusion, the tax burden would be severe for many taxpayers. Fortunately, the IRS rules allow most taxpayers to take advantage of this capital gains exclusion. Read more on this here.
How should I report the sale of my home on my tax return (Form 8949)?
The gain (or loss) from the sale of a home is typically reported on your tax return. In certain circumstances, you may be eligible to claim a special capital gains exclusion for this income. Generally speaking, you qualify for the exclusion if:
- The home was your primary residence
- You owned the home for two or more of the five years immediately preceding the sale
- You lived in the home for a total of two or more of the five years immediately preceding the sale. This time does not have to be consecutive.
If you are eligible, you can exclude up to $250,000 in gains from the sale of your home from your income. Married taxpayers filing a joint return can exclude an amount up to $500,000.
If you are eligible for the exclusion and your gains from the sale of the home do not exceed the amount you can exclude, then you do not need to report the sale on your tax return.
Capital gains from the sale of your home that do not qualify for the exclusion are taxable.
Some taxpayers must report the sale of a home. You must complete Form 8949, Sale and Other Dispositions of Capital Assets and file it with your tax return if:
- You do not qualify for the capital gains exclusion
- The amount you received exceeds the capital gains exclusion for which you are eligible
- You receive Form 1099-S, Proceeds from Real Estate Transactions (if you receive this form then you must report the sale even if you are eligible for the exclusion)
- The home you sold was rental property (report this type of sale on Form 4797, Sale of Business Property)
- The home you sold was a vacation home or inherited property that was not used as your primary residence (report these sales on Schedule D, Capital Gains and Losses)
Publication 523, Selling Your Home provides detailed information about who can claim the capital gains exclusion and special circumstances that may affect eligibility. It also contains worksheets to help you calculate your adjusted basis in the home as well as figuring your total gain (or loss) and how much of the gain you can exclude.
If you converted your primary home to business use (including as rental property) then the amount of capital gains exclusion you qualify for will be reduced by the amount of depreciation you claimed for the business use of the home. You can learn more about how to calculate capital gain (or loss) from homes used for business in Publication 523.