When we moved into our current home, a house not too far from our house had been listed for sale a few times but hadn’t sold. I learned from our real estate agent – and some chatty neighbors – that the house was purchased when prices were relatively high and it was considered difficult to unload due to certain associated costs. A few months ago it sold for $300,000 over the original asking price, making it almost twice as expensive as most other homes in the area.
It was not an anomaly. Last year, a client of mine listed her home and told me she wasn’t sure she could get the appraised value. It was in a lovely neighborhood, but she hadn’t been able to do any renovations, so it had the same 1960s facilities as when she moved in – in the 1990s. an email saying she had received a cash offer, as is, for nearly $250,000 more than requested.
You probably have a similar story to yourself. Housing prices have soared across the country, much faster than wages. Fortune Remarks that house price growth (20.6%) is four times greater than income growth (4.8%) over the past year.
I’m not going to use the b-word… but you know what I’m thinking.
Many owners are hoping to take advantage of rising prices before the market slows or crashes. As a result, my inbox has been full of your questions about the tax implications of selling your home. Here is a brief overview of some of the most popular.
I know about the one-time capital gains exemption, but what happens when I sell another home in my lifetime?
There is no longer a single exemption — that was the old rule, but it changed in 1997. Section 121 the capital gains exclusion of up to $250,000 of your income gain, or $500,000 for married taxpayers, is available to all eligible taxpayers who have owned and lived in their home for two out of five years preceding the sale. The years do not have to be sequential; you can live in the house in year one and year five and still qualify.
The capital gains exclusion applies to your principal residence, and even if you only have one at a time, you may have more than one in your lifetime. You can take advantage of the exemption multiple times as long as you meet the criteria.
What if I’m 55 or older?
Nothing. Your age makes no difference. Previously, there was a provision that allowed homeowners who were at least 55 years old to claim a one-time capital gains exclusion. Again, this is no longer the case. The capital gains exclusion is available to all eligible taxpayers who have owned and lived in their home for two of the five years prior to the sale, regardless of your age.
During the pandemic, I bought a second home in North Carolina. If I sell my house in New York, am I entitled to the exclusion?
If you own more than one home, you can only exclude the gain from the sale of your primary residence. If you have two homes and live in both, your primary residence is usually the one you live in most of the time. You’ll want to count the days you were at each property. That said, facts and circumstances may also apply: where you are registered to vote, where you pay your state and local taxes, and where you have your driver’s license can also help determine your primary residence.
Can I still claim the exclusion if my home is in trust?
It depends. Generally, a revocable trust that meets certain criteria may be disregarded for federal tax reasons. This means that the ownership of the trust would be ignored and you would be treated as the owner. In this case, the exclusion would still apply.
However, a revocable trust that is not bypassed, or an irrevocable trust treated as a separate entity for federal income tax purposes, will generally not qualify under section 121. If so , the exclusion will not apply.
I sold my house for $550,000. Does that mean I have to pay capital gains on the whole thing?
No. There are two concepts here that are very important: the base and the capital gains exclusion.
Let’s talk about the basics first. The basis is, in its simplest form, the cost you pay for the assets plus the adjustments. When it comes to real estate like your home, your basis is your cost plus any major improvements. For example, if you buy a house for $150,000, that’s your base cost. If you make a capital improvement – a major change that adds permanent value as an add-on – it will increase your base. Suppose the addition costs you $40,000. Your base is now $190,000, which is $150,000 (original purchase price) plus $40,000 (addition).
When you sell your home, your gain is the difference between the selling price and your base. So to continue the example, if you sold your house for $550,000 and your base was $190,000, your gain is $360,000, or $550,000 minus $190,000.
Now let’s add the capital gains exclusion. The exclusion can reach $250,000 for single taxpayers or $500,000 for married taxpayers. If you are married, you would subtract $500,000 from your gain (in this case, $360,000). Since the exclusion is greater than your gain, you owe no capital gains tax on the sale. If you were single, you would subtract $250,000 from your gain (again, $360,000) – because the gain is greater than your exclusion, you would have to pay capital gains tax on the gain of 110 $000.
This amount is the gain, not the tax due. If you owned your home for a year or less and then sold or otherwise disposed of it, your capital gain is short-term and you will be taxed at your ordinary tax rate. On the other hand, if you have owned your home for more than a year, your capital gain excluding exclusion is permanent. For 2022, the long-term capital gains rates for most capital property are 0%, 15% or 20%, depending on your taxable income.
What if I lost money when selling my house?
My God, I hope you haven’t lost any money on this market. But if you did, you can’t claim a capital loss on the sale of a personal residence, no matter how bad it hurts.
When I sold my house, I had to pay off my mortgage and my property taxes. Does this also reduce my gain?
No. When calculating your gain, you don’t consider your mortgage or property taxes to be the seller. You’ll want to use the formula (sell price minus base), not cash on hand.
That said, if you paid interest when paying off the mortgage, you may be able to claim this as a mortgage interest deduction on Schedule A if you itemize. The same goes for property taxes.
How will the IRS even know that I sold my house?
You’d be surprised how many elements of a real estate transaction can trigger some sort of tax form, from satisfying your mortgage to paying a third party upon settlement. Most often, however, Form 1099-S is used to report the sale or exchange of real estate. When the IRS receives the Form 1099-S, it compares it to your tax return. If they don’t see the noted transaction, you may receive a notice, such as a CP2501, asking for more information.
I was thinking of doing a similar exchange for my house and…
I will stop you there. As part of the tax reform, Item 1031 exchanges only apply to real estate used for business purposes or held as an investment. The so-called trade-in or “like-kind” trade-in can be a great way to avoid immediate recognition of the gain, but the provision doesn’t apply to your home. And don’t think you can move out and list your house just to get around the rule; an exchange of real estate held primarily for sale is not considered a like-kind exchange.
Questions?
Selling a home in this market may seem like a piece of cake, but the tax consequences could complicate things. Understanding what you need to know up front makes for much smoother navigation – and if you have any questions, be sure to consult a tax professional.
This is a regular column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest tax news, tax law and tax policy. Look for Erb’s column each week in Bloomberg Tax and follow her on Twitter at @taxgirl.
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