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.