What you don’t know – but should – really can hurt you — to the tune of $119,000 in federal income taxes.
That’s assuming you’re married, selling your home, and have a federal tax rate of 23.8 percent for the transaction (a capital gains rate of 20 percent plus 3.8 percent net investment income tax). Change the facts and the tax benefit is a little less.
The savings stem from the fact that, if you satisfy the tax rules, you can exclude up to $500,000 of the gain from selling your primary residence.
1. You may be able to exclude some or all of your gain. Generally, under federal tax rules you can exclude up to $250,000 of the gain from the sale of your home — $500,000 if you’re married and file a joint return. If you own more than one home, only your primary residence is eligible. There are no age limits to qualify, however you must satisfy three basic tests. You cannot have excluded gain from the sale of another home within the last two years. Further, you (or your spouse) must have owned your home and you both must have occupied it as your main home for any two of the last five years. If one spouse doesn’t qualify under these tests, the qualifying spouse may exclude up to $250,000. (This exclusion replaced the once-in-a-lifetime exclusion for those over 55 and the gain rollover option for those reinvesting in a new home within two years.)
2. You can use the gain exclusion more than once. There are no restrictions that limit the number of times you can qualify for the exclusion, as long as you satisfy all of the tax rules each time. That means as soon as you’ve owned and occupied a new primary residence for two years and met the other requirements, you’re potentially eligible.
3. If you claimed a home office deduction or rented your home, a portion of the gain may not qualify for exclusion. If you ever used a portion of your home as an office or rented it out, you may still qualify for the exclusion as long as you satisfy the tax rules for excluding gain. However, you’re not allowed to exclude an amount equal to any depreciation that you deducted as a business expense after May 6, 1997.
4. If your primary residence was once your second home or vacation home, some of the gain may not qualify for exclusion. If you’re selling a home that was not your primary residence the entire time you owned it, you may have to prorate the amount you can exclude. This proration only applies to the period of time beginning after 2008. The percentage of gain you can exclude is determined by the following ratio: number of years occupied as primary residence / total number of years owned.
5. The cost of certain home improvements can increase your tax basis and thus decrease your reportable gain. For tax purposes, your basis in your home is the amount used to calculate gain or loss. Typically, your basis starts with the amount you paid for the home, including certain fees you paid. The cost of improvements you make — such as upgrading appliances, adding a fence, replacing flooring or adding a security system — increase your basis. The cost of repairing damage resulting from a casualty — such as fire, flooding, or theft — also increases your basis. An increase in basis reduces your gain when you sell – but only if you have adequate records to support the amounts involved.
6. If some or all of your mortgage debt is canceled or forgiven as part of the sale of your home, you may have taxable income. The amount of any decrease in the debt you owe on the home you’re selling — for example, in the case of a short sale — becomes taxable to you as income. In the past the Mortgage Forgiveness Debt Relief Act provided an exception to this rule, but the Act expired last year and Congress has not yet extended it. Stay tuned as the Act might be extended retroactively for 2015.
7. You can’t claim a loss from selling your home. Even if you sell your home for less than you paid for it or less than the outstanding mortgage, you don’t have a loss for tax purposes.
As with anything in the federal tax code, there are a number of details and exceptions to these general rules for selling your home.