The housing market is hot right now, that is if you’re on the selling end. Home prices are at record highs, home builders can’t keep up with demands, and there’s a shortage of homes for sale, especially affordable homes for first time buyers. As a seller, this is great news and these increased values look appealing for your bank account, but what does it mean for your taxes? Will you end up paying capital gains tax, which, if considered short-term, could be taxed at up to 37% in 2019? Maybe, but maybe not.
The IRS has established Code Section 121, Exclusion on Gain from Sale of Principal Residence, that could help minimize or altogether exclude any taxable gain. For single taxpayers, this exclusion allows up to $250,000 of capital gains to be excluded from tax. That number doubles to $500,000 for married filing joint taxpayers.
However, there are certain requirements that need to be met. The three primary requirements to qualify for the exclusion are:
Principal Residence: The house or real estate must be your primary residence at time of sale.
Ownership and Use: You must have owned and resided in the home for at least two out of the last five years prior to the sale.
Frequency Limitation: A taxpayer cannot use the exclusion if it has been used on another home in the previous two-year period, or for a like-kind exchange, the previous five-year period.
So, what if you don’t meet these requirements? There may still be a reduced exclusion for you, if you’ve sold or exchanged the home due to a change of employment, health reasons, or certain unforeseen circumstances. The reduced exclusion would need to be calculated and would depend on several factors.
If the above requirements do not apply, then only the gain on the sale will be treated as taxable. However, expenses incurred during the sale of the home, as well as any improvements or remodeling costs incurred while owning the home can be used to increase the basis. This, subsequently, decreases the amount of recognized gain that would be considered taxable.
What kind of tax will you be paying on this recognized gain? Well, if you’ve owned the home for less than a year, the recognized gain will be treated as short term capital gain and taxed at your normal tax rate, anywhere from 10 - 37%, depending on your filing status and income level. If you’ve owned the home longer than a year, the recognized gain will be treated as long term capital gain and taxed at a lower rate, 0%, 15%, or 20%, depending on your income level.
With correct tax planning, you may be able to avoid a large capital gains tax on the sale of your home. If you’ve recently sold your home, or are thinking about selling, consult with your tax advisor regarding your individual situation to minimize, and possibly fully exclude, any potential capital gains tax that you may be liable for.
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