What are the Tax Implications of Selling?
Understanding the Tax Implications of Selling Your Home
While the housing market has slowed over the past year, home prices in many areas remain elevated. This accumulated appreciation means that sellers should anticipate potential capital gains tax liabilities upon selling their property. Increased property values lead to greater sale proceeds but can also result in higher taxes owed.
Capital Gains Tax: What You Need to Know
When selling a primary residence, sellers can exclude up to $250,000 in gains ($500,000 for married couples filing jointly) if the home was their primary residence for at least two of the last five years. However, the dramatic increase in housing prices may bring more sellers closer to this exclusion limit. Established in the Taxpayer Relief Act of 1997, these exclusion amounts have not changed in over 25 years.
To qualify for this exclusion, you must meet the IRS's ownership and use tests: the property must have been owned and used as your principal residence for at least two out of the last five years. Importantly, this exclusion applies only to primary residences, not investment properties.
Capital Gains Tax Rates
If you owe capital gains tax, the amount you pay will depend on how long you owned the home, your filing status, and your income. Homes sold within one year of purchase are taxed at ordinary income rates (up to 37%), while homes owned for more than one year but less than two years may qualify for lower long-term capital gains rates. After two years, you may qualify for the exclusion.
Reducing Capital Gains Tax
Calculating your gain is more complex than simply subtracting your original purchase price from the sale price. Instead, taxes are based on the "amount realized," which factors in various selling expenses. Here are key expenses that can help reduce your taxable gain:
When You Buy: Keep records of closing costs, including title and legal fees, which may increase your cost basis.
While You Own: Document improvements like remodels, additions, and major repairs; regular maintenance doesn’t count.
When You Sell: You can deduct selling expenses like real estate agent commissions, legal fees, and advertising costs from the sale proceeds.
Documenting Improvements and Expenses
Keeping detailed records is crucial. Maintain receipts, invoices, and descriptions of any improvements, along with relevant permits and photos. This documentation can be essential for establishing your adjusted cost basis.
Final Thoughts
Understanding the tax implications of selling your home is essential for financial planning. A tax professional can provide personalized advice, helping you navigate your specific situation regarding adjusted cost basis and potential gains.