Primary Residence Exemption From Capital Gains Tax – Home prices and home equity have increased significantly over the past few years, which may leave you wondering if you should sell your home. Wouldn’t selling your home be even more tempting if buying another home wasn’t so difficult?
If you’re thinking about selling a home, then you’re probably focused on marketing time, payments, moving, and lifestyle changes. One thing you may have overlooked is the tax considerations of selling a home.
Primary Residence Exemption From Capital Gains Tax
Primary homes are considered capital assets, as are investments such as stocks and bonds. Capital assets are normally subject to capital gains taxes when they are sold. However, primary homes may qualify for favorable capital gains treatment called the Section 121 exclusion.
Are There Tax Penalties For Selling A House Before 2 Years?
For most homeowners, the Section 121 exclusion is one of the biggest benefits of the current tax code. Do you know how this exclusion works and how to make sure you qualify?
Before making the decision to sell your home, start calculating your capital gains. Gain on the sale of a principal residence is calculated as follows:
The IRS allows homeowners to exclude a portion of your home sale from capital gains taxes if you have owned your home and lived in it as your primary residence for two of the past five years. The 24 months do not have to be consecutive months, but a total of 24 months within a 5-year period. If you qualify for the 2 out of 5 year rule, then you have the following gain exclusion when you sell your home:
The benefit mentioned above does not include outstanding mortgage. If there is an outstanding mortgage on the home, this will not affect the Section 121 capital gain exclusion amount. Please read example #1 below to see how mortgages do not affect the total capital gain.
Avoid Capital Gains Tax In 2023: What To Do?
Even if you haven’t lived in your home for two out of five of the years before selling the home, there may be a way to qualify for a partial gains exclusion. For example, you might be eligible for a partial earnings exclusion if you had to move for work-related reasons, health-related reasons, or due to unforeseen circumstances such as divorce or the birth of two or more children from the same pregnancy.
Homeowners can take advantage of this Section 121 capital gains exclusion once every two years. For example, if you have two homes and have lived in both for at least two of the past 5 years, both homes are not eligible for the capital gains exclusion at the same time.
Jordan lived in her home for these 6 consecutive years. When she listed her home for sale, Jordan still had an outstanding mortgage of $75,000 on her home. As mentioned above, mortgages are not part of calculating the total Section 121 earnings exclusion. Jordan has a total gain of $210,000 ($560,000 sale price – $350,000 purchase price). For a single taxpayer, none of this gain is subject to taxes because it is less than the exclusion amount of $ 250, 000. Time for Jordan to enjoy her election celebration.
Martha and Paul have raised their children in this home for the past 23 years, except in 2006 when they rented their home for a sabbatical. The total gain on the sale of the home is $650,000. They will only pay capital gains on $150,000, because $500,000 is subject to the Section 121 gain exclusion.
Selling And (perhaps) Buying A Home Under The Tax Cuts And Jobs Act
Samuel and Taylor bought a vacation home on the coast in 2010 for $300,000. They used the home as a vacation home for the first 10 years, and then converted it to their primary residence in 2020. Samuel and Taylor would like to sell their home sometime in 2022 for $500,000.
The first 10 years of ownership are considered non-qualified use. Non-qualified use is any period after 2008 when the home was not used as a primary residence. Examples of non-qualified use are vacation homes, rental properties, investment properties, or homes used in the conduct of business. Homeowners cannot take the full tax-free exclusion under Section 121 if property was held and used for a non-qualified use before it is held as a primary residence (qualified use).
In this example, 2/12ths of the total $200,000 of capital gain can be excluded from taxable income ($33,333) as qualified under Section 121 and 10/12ths ($167,666) of the total gain must be included in taxable income as a non-qualified use under Section 121.
*There are some exceptions to non-qualified use. They are listed under the Business or Rental Home Use section.
Home Sale Exclusion From Capital Gains Tax
Miguel and Jasmine purchased their primary home in 2012 for $500,000. They moved out of the home and began renting it out in 2020. They sold their home for $1,000,000 in 2022.
Because they wanted to use the Section 121 gain exclusion, they had to sell the home in 2022. To express the importance of this sale time, here is a detailed timeline:
2022 – home used as a rental home for most of the year and sold for $1,000,000 on May 15, 2022
Because they sold this home during 2022, which meets the 2-of-5-year exclusion rule, they can use the full tax-free exclusion on the $500,000 gain. ** They may owe tax on the depreciation recapture.
Avoiding Capital Gains Tax On Real Estate In 2022
However, if they had waited to sell their home until 2023, Miguel and Jasmine would have paid capital gains tax on the entire $500,000 gain because they would not have qualified for the 2-of-5-year exclusion rule in this case. As this example illustrates, paying attention to your timeline for selling a home is critical.
As you may have gathered from this blog post, buying and selling homes can involve complicated tax planning. Considering the extended seller’s market, our team has worked on several tax planning scenarios and strategies for different clients. If you’d like to talk to us about your unique scenario, please contact us at hi@ or 503-905-3100. So you sold your home and just left the closing attorney’s office with a fat check. Not just a big check—but the biggest check you’ve ever held in your sweaty palm.
. And capital gains are taxed at different rates depending on whether the investment you made was short-term (less than one year) or long-term (more than one year). The rates also vary based on your income.
But, hey, don’t lose hope just yet. The great news about selling a home is that the profit is often exempt from capital gains taxes. That’s right! Duty free, baby. But just like anything tax-related, there are a few hoops to jump through.
A $500,000 Gift From Uncle Sam? Maybe. Capital Gains, You And San Francisco Real Estate With Kevin And Jonathan, Vanguard Properties
Okay, so here’s the deal. If the home you sold was your primary residence for at least two of the last five years, you don’t have to pay capital gains taxes on your profit up to a certain amount. And the IRS is pretty generous (for once!) about how much profit they exclude from taxes.
If you are single, any benefit up to $250,000 is excluded from taxes. For married couples filing jointly, the amount doubles to $500,000.1 And profit doesn’t simply mean how much money you got when you sold your house. And that’s a relief, because that check you get at closing could be a lot bigger than what’s considered profit, especially if you’ve worked hard to pay off your house.
Profit is the sale price minus the original purchase price and the cost of improvements, fees and commissions. Now if the housing market in your area went crazy, and you cleaned up because of the sale of your house, you only pay taxes on the amount above the threshold of $250,000 or $500,000.
Let’s look at an example. Say you and your spouse bought a house 10 years ago for $300,000 in a new part of town. You followed our recommendations and put 20% down ($60,000) and got a 15-year fixed mortgage. After 10 years of payments, you only owed $93,000 when you decided to sell. Home values in your area shot up like crazy, so you were able to sell your home for $900,000! Blast! You couldn’t stop smiling for a week.
How Much Is The Capital Gains Tax On Real Estate?
So to figure out your profit, you take $900,000 and subtract the original $300,000 sales price, about $55,000 in commissions and fees and let’s say $20,000 in home repairs (roof and new furnace). That equates to a profit of $525,000. Since the tax-free threshold for married couples is $500,000, you will pay capital gains taxes on only $25,000.
So, $525,000 is a big pile of money, but since you only owed $93,000 on your home, you actually walked away with $752,000. Here’s the math: $900,000 (sale price) – $55,000 (commissions). and fees) – $93,000 (mortgage payoff) = $752,000.
Now to your tax bill. Short-term (less than one year) capital gains are taxed at your regular income tax rate. Long-term (more than one year) capital gains are taxed according to your income. If your taxable income is less than $41,675 for single filers or $83,350 for married couples filing jointly, your
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