Thinking about selling your personal residence, but afraid about the tax you may have to pay? In most cases, you do not usually pay taxes when you sell your personal residence. If you have a gain on your home, I’m sure you are thinking: “well I have to pay tax on that!”
There are exclusions of 250,000 for single filers and 500,000 for married filing joint filers. In most cases, this excludes most, if not all, of your capital gain. It seems too simple for the IRS to just exclude these large amounts, right? Yes, in order to get these exclusions you need to qualify - nothing is easy with the IRS!
How do you qualify for the exclusions?
- Ownership & Residence Test: You must have owned the home for 2 years out of the last 5 years before the sale of your home. The home also must have been your primary residence for 2 of the last 5 years before the sale. The 2 years does not have to be continuous for ownership or residence test. You must meet both of these requirements!
- Timing Test: You have not used the exclusion on the sale of another home in the last 2 years.
There is an automatic disqualification from the exclusion if you acquired your home from a 1031 exchange in the last 5 years OR if you are a non-tax resident. There are also exceptions if you recently got separated from your spouse due to divorce or death or your previous home was destroyed or condemned, but I will leave that discussion for another time.
Can I qualify for a partial exclusions?
Yes! Partial exclusions usually occur when homeowners do not meet the Residence test due to change in employment, health issues, or other unforeseen circumstances (divorce, having twins, the death of a spouse, etc). If you fall into one of these categories then you may qualify for a partial exclusion.
Other situations to consider:
- Renting out part of your personal residence: If part of your home is used as a rental property then that portion is not eligible for the exclusion. A separate gain or loss is calculated on the portion that is rented.
- Using Home for Business: If you claim a home office deduction - then you will not be able to exclude a gain from the portion that is used for business purposes. Same idea as renting out a portion of your personal residence.
How do you calculate the cost of your home?
- The original purchase price of the home - usually on your purchase HUD
- Add Costs of any major improvements (roof, new kitchen, new master bathroom, etc) - Repairs & Maintenance do not apply and cannot be added to costs
- Add any selling costs incurred during the sale of your home (commissions, closing costs, etc)
Once you figure out your costs subtract that from the selling price. If the costs exceed the selling price you have a loss. If the selling price exceeds the costs, you have a gain!
Before you sell your home make sure to discuss it with your CPA to determine whether or not you will have to pay tax. All situations are so different! Make sure to get advice to make the best tax decision for your wallet.