Are you getting ready to hit the road and start your nomadic life? Chances are you might also be getting ready to sell your home. Here are some tips to help you understand taxes when selling a home.
Gain
The IRS has exceptions for taxpayers who sell their main home. This means you may qualify to exclude from your income all or part of any gain from the sale. The IRS allows taxpayers to exclude up to $250,000 (single) or $500,000 (for married filing jointly) from income on a tax return.
If your gain is not greater than these numbers, then there is no need to report the sale of your primary residence on your tax return.
Woohoo! Time to rejoice, right?
Hold on. Let’s make sure you are calculating everything correctly first.
Calculating the gain on your home takes into account several factors including basis, improvements, credits and selling costs. The basis is the original price you paid for your home. You’ll also need to factor any improvements you’ve made to the home while living there. Improvements to your home increase the basis in the property. You can also take into account any selling costs including commissions paid.
Let’s look at an example.
You are single and you bought your home in 2010 for $250,000. You added on a new patio and installed an HVAC system for a total of $15,000. Your basis in the home is now $265,000. You sell the home in 2019 for $425,000. This means you have a gain of $160,000. This is below the $250,000 amount allowed as an exclusion by the IRS, so you don’t need to report any gain on the sale of your primary residence.
2010 Purchase price, original basis = $250,000
Improvements to home = $15,000
Adjusted basis to home = $265,000
2019 sale of home = $425,000
Gain = $160,000 < $250,000
Worksheets
Worksheets included in Publication 523, Selling Your Home, help you compute the:
- Adjusted basis of your primary residence
- Gain or loss on the sale
- Excluded gain on the sale
Keep in mind, there are some stipulations you must meet to qualify for this exclusion.
As you can imagine gain will vary for each individual.
Ownership and use
To claim an exclusion on taxes when selling your home, the taxpayer must meet the ownership and use tests. What is this you ask?
You must have owned the home for at least 2 years immediately preceding the date of sale. Also, you must have lived in the home as your primary residence for at least two of the last five years. Also, you may not use this exclusion more than once every two years.
There are a few exceptions to these rules for someone moving for work purposes, military, etc. If you think you qualify for an exception, I suggest you talk with a tax professional to confirm the details. As you know tax law is always changing, so make to check on any recent changes related to selling a primary residence.
Renting out your home
There are some of you who might consider renting your home as you learn if this lifestyle is for you. This way you have a place to come back to should the nomadic life not feel right to you. Under current tax law, you can do this! As long as you have two years of ownership and use during the past five years before the selling date, you qualify for the exclusion. Yes. You read that right. You can move out of your house for up to three years and still qualify for the exclusion.
Make sure you keep good records and track this time carefully. You must sell the home before the three years run out to qualify for the exclusion. This is a great way to avoid taxes when selling a home and still test out the waters of the nomadic life.
Loss
If you experience a loss when you sell your primary residence, the loss is not deductible. Unfortunately, there is no way around it. Simply put a loss on the sale of a primary residence is NOT deductible.
If you turn the property into a rental property and hold onto it for more than three years, then the property can be treated as a business or investment property. This is the only way a loss might be deductible on real estate. The choice is yours if you’d like to become a landlord or not.
Reporting the sale
If you have more gain than the exclusion allows (greater than $250,000 for single filers and $500,000 for married filing jointly), then you should receive Form 1099-S. This form reports proceeds from real estate transactions and is used to report the sale of the property on your personal income tax return.
Let’s look at an example where you might have to report income from the sale of your primary residence.
You are married and you bought your home in 2000 for $250,000. You updated the kitchen, installed new windows and installed a new HVAC system for a total of $75,000. Your adjusted basis in the home is now $325,000. You sell the home in 2019 for $925,000. This means you have a gain of $600,000 and a reportable capital gain of $100,000.
2000 Purchase price, original basis = $250,000
Improvements to home = $75,000
Adjusted basis to home = $325,000
2019 sale of home = $925,000
Gain = $600,000 > $500,000
Capital gain on the home = $600,000- $500,000 = $100,000
What About Multiple Homes
If you have more than one home, the one you live in the most during the year is your primary residence. This is also most likely your legal mailing address and where you register your vehicles and get a driver’s license.
If you sell your second home, the profit on the sale is considered a capital gain. Vacation or second homes are treated as a personal asset and are reported as such when they get sold.
However, it might be possible to exclude some of the gains if you convert your second home to your primary residence. The same two-year primary residence rule would apply. Remember, you can only exclude primary residence gain once every two years.
Tax Credits and Basis
If you used the first-time homebuyer credit to purchase your home, there are special rules that apply to the sale. It’s most important to know that you will owe any amount still owed back as part of your taxes for that year. For example, if you received $7,500 in credit and paid back $1,500 of that so far, you will owe the remaining balance of $5,000 on that year’s tax return. It’s important to plan for that and also to make sure the sale gets reported on your return.
If you’re not sure of the amount of your credit or how much you repaid, use this IRS tool to get account information.
If you took any energy credits on your home for installing windows, doors, solar, etc., then that comes off of your basis. For example, you have a basis of $350,000 in your home. However, you took $3,000 in energy efficient credits. This means your new adjusted basis is $347,000. You can still factor in improvements and such to arrive at your final adjusted basis.
I realize selling a home might be an important step as you prepare for nomadic life. If you’re interested to know more about taxes as a nomad, check out this blog post.
Otherwise, what other questions do you have about taxes when selling your home?
