Tax Tips
Tax Rules for Selling Your Home - April 2005
Richard Scrivanich - Partner
Selling Your Home? Know the Tax Rules
A year ago, many homeowners thought the increase in home prices had peaked. However, recent surveys show that prices of homes in many markets nationwide have continued to appreciate significantly.
If the value of your home has skyrocketed in recent years, you may be considering cashing in on this windfall. Even if the thought is just beginning to cross your mind, you should be aware of the tax rules that govern the sale of a residence, since careful planning is the key to keeping the most profit from the sale of your residence. The length of time you’ve owned your home, the length of time you’ve lived there, and the type of ownership will affect the tax treatment when you sell it.
A large exclusion from income
The first thing you should consider is arranging, if at all possible, to qualify for the exclusion of gain on the sale of your home. A married couple filing a joint return can exclude from income up to $500,000 of the gain on the sale of their principal residence. For a single person, the amount of tax-free gain can be up to $250,000.
Prior to 1997, you were only eligible for a tax break if your were age 55 or over, or if you rolled the profit of your home sale into your next residence and the sales price of the residence sold exceeded the cost of the new residence. Since that time, in addition to the $500,000/$250,000 exclusion, you no longer have to wait until you are age 55 to elect to exclude all or part of the gain and you can take advantage of this tax break every two years, instead of once in a lifetime.
Qualifying for the exclusion
To be eligible for the exclusion, you and your spouse (if you are married) must have owned and used your home as your principal residence for at least two of the five years ending on the date of the sale. The periods do not have to be consecutive, as long as they add up to two years. Short, temporary, and seasonal absences are not counted against your period of use. If you have more than one residence, only the sale of your principal home (the one you live in the most) qualifies for the exclusion. The exclusion may not be used more frequently than once every two years.
Special provisions apply if, as a result of some unforeseen event such as a job change, illness, death of a spouse, divorce, or some other hardship, you are forced to sell your home before meeting the two-year residency requirement. Depending on your circumstances, gain may be fully excluded or the exclusion may be prorated based on the amount of time you lived in the house. For example, if you had to sell your home after one year for health reasons, you could take half of the exclusion, which means your first $125,000 of profit would be tax-free if you’re filing as a single ($250,000 if married filing jointly).
Calculating your gain
In determining your gain, don’t forget to account for qualified expenses that can be added to your home’s purchase price to increase your cost basis on your original house, including the costs of the sale. Increasing your cost basis helps to reduce the gain on the sale of your house and may lower or eliminate a potential tax bill. Qualifying expenses include home improvements, such as adding a room or a new roof, and the cost of settlement fees, property inspection fees, and title insurance.
If your gain exceeds the exclusion amount, there is no way to avoid a tax bill. Rolling over your gain into a new residence is no longer an option. You must report your nonexcludable gain on your tax return and compute your tax at the long-term capital gains rate.
Think ahead
Careful planning is the key to keeping the most of your home sale profit. If you are considering a possible sale your residence in the next several years, now is the time to consider the possible impact of the residency and ownership requirements, as well as your marital status, on the tax impact of any sale. To determine your eligibility for the exclusion or to factor it into your tax planning, please call us.
If you have any questions regarding the tax rules for selling your home or any other tax matter, please call me at (562) 698-9891.
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