DISCLAIMER: This article is meant for educational purposes only and is not intended to be construed as financial, tax, or legal advice. HomeLight always encourages you to reach out to an advisor regarding your own situation.
You cleaned every surface, opened your home to a bunch of strangers, and negotiated like a pro. After all that you can finally say you’ve made it to the finish line. You sold your house (phew!) and for a nice profit to boot!
With a lump sum so liquid you could run it through your hands, your grip may tighten. How much of the profit on your home is truly yours, and how much will Uncle Sam be reaching into your pocket to collect?
It’s true, the government wants a piece of any “capital gains” (aka profit) you make from selling off assets like stocks, bonds or property. Lucky for you, the American dream of homeownership is more than just a philosophy. It’s also the basis for generous tax breaks.
Whether you have to pay taxes on the sale of your home depends on how much you made, how long you lived in the house and any life circumstances that may qualify you for additional breaks.
Here’s exactly what you need to know to figure out how much money (if any) from the sale of your home you’ll need to give back to the government.
First Off, How Much Did You Make On Your Home Sale?
The capital gain on the sale of your home is calculated by subtracting your “cost basis” from your sale price; the remaining balance is considered your capital gain and is the taxable amount.
Let’s start with the cost basis. Simply put, it’s the original cost of the home (what you paid for it).
If you inherited the home, the cost is the fair market value of the home at the time that the former owner died. If you built your home from scratch, you can throw in land and building costs.
The “adjusted cost basis” accounts for any costs you poured into your home in the form of “capital improvements.”
Figure In Capital Improvements to Reduce Your Tax Burden
Capital improvements are things like kitchen and bath remodels, or big additions like a swimming pool or new roof. They minimize your capital gains by adding to your adjusted cost basis.
Figuring in capital improvements will be much easier if you’ve kept a record of improvements you made over the course of ownership of the house, so make sure you always hang onto those receipts. Don’t forget that capital improvements do not include items necessary for the maintenance and repair of your home—only those improvements that have added to or increased your home’s value.
Toby Mathis, Esq., a founding partner of Anderson Law Group, tax law specialist and real estate investor who knows the ins and outs of real estate tax liability and exclusions, shares some capital improvement costs that people commonly overlook:
- Land survey fees
- Title insurance
- Recording fees
- Legal fees
- Utility services
- Cost of title abstracts
“If you have to pay costs that normally a seller would pay, like sometimes they’ll say ‘hey, I’m going to sell you the house, but you need to pay the back taxes,’ you’d add that to basis,” says Mathis. “Back interest if you’ve taken over mid-note [is another capital improvement]. If you’re covering the title recording, and those types of things.”
One last overlooked capital improvement is adding a water treatment system to your home.
Based in Las Vegas, Mathis, says, “[Here] the first thing everybody does is get a water treatment. We have lots of minerals in the water, so they buy soft water treatment; they don’t get to write that off, they just add it to the basis.”
The IRS’s page 7 of Publication 551 offers a hypothetical example for calculating your basis.
In a nutshell, the core formula is:
Original cost of asset
Improvements to asset
Repair of damages to asset
Depreciation to asset
Deducted casualty loss to asset
Adjusted basis of asset
There’s a Good Chance You Won’t Have to Pay Any Taxes On Your Home Sale: Here’s How
Say you had a job that paid $250,000 a year. In 2018, you would owe $63,189.50 in federal income tax alone.
Now imagine getting that same $250,000 windfall—only it’s completely tax free.
That’s the gift of the American home sale capital gains exclusion. To be clear: You pay zero taxes on up to $250,000 in gains on the sale of your home, so long as you meet these criteria:
- You’ve owned your home for at least two years.
- The home was your primary or principal home for a minimum of two years out of a five year period, counting backward from the date of sale.
- You haven’t taken this exclusion in the two years before the sale of your home.
To qualify for the exclusion, you only need to have resided in your primary residence for any two of the last five years, stresses Mathis. The years don’t have to be consecutive, or the most recent two years, to count. But capital gains taxes will apply if your home is strictly an investment property.
Home Sale Tax Breaks Are Even Better for Married Couples
If you file a joint tax return with your spouse, the capital gains exclusion on the sale of your home doubles to jaw-dropping $500,000 for married couples.
That’s something to keep in mind if you’re selling your home while going through a divorce.
“Remember that if you decide to sell that home, and for some reason you move out, or you sell it five years later after making it a rental, and now you’re divorced—you’re only getting a $250,000 capital gains exemption,” advises Jordan Bennett, a top 1% real estate agent in Mission Viejo, CA.
Make sure the terms of ownership are spelled out in your divorce decree, especially if you know in advance that the home will be sold shortly after finalizing your divorce.
Mathis has witnessed many people deed the house to their ex-spouses, only to get hit with a rude-awakening come tax time. Mathis explains, “If the house is going to be sold after the dissolution, you need to talk to the accountant to make sure you don’t inadvertently cost yourself all or part of the exclusion. The best example is if the house had gone up $500,000 in value and you were splitting it. If you give it to your spouse and they sell it, they only get a $250,000 exclusion, and you get none.”
A tax professional will be able to help you understand the best way to preserve that exemption, so make sure you consult with someone before moving forward with the divorce or the sale.
According to Mathis, “Once you determine whether you’re eligible [for the exclusion], then you can just go to the next step.” Sellers should then ask themselves, “If I’m not eligible, would I be eligible for a partial exclusion?”
How To Meet the IRS Halfway on Home Sale Capital Gains
If you aren’t eligible to take the full exclusion, don’t worry; you may be eligible for a partial break.
A partial exclusion pro-rates or reduces your tax liability in the case that you don’t meet the full exclusion requirements.
Mathis explains how partial exclusions are calculated, “Let’s say you’re single and you’re eligible for $250,000 of exclusion on the gain. You only lived in [the principal residence] for a year, then you would say, what would I have been entitled to? If I had lived there two years, it would have been $250,000, but I only lived there for a year, so I get 50% of it.”
The IRS also says that you may qualify for a partial exclusion on the gains from the sale of your home if any of the following apply to your situation:
- You were transferred or took a job that is more than 50 miles than your previous work location.
- You were forced to make a health-related move, either for yourself or to care for a family member.
- You were directly impacted by an unforeseeable event and forced to move. Unforeseen circumstances may include natural disaster, divorce, the birth of two or more children from the same pregnancy, or unemployment.
Once you know that you’re eligible for a partial exclusion, the amount of time you lived in the primary residence will determine how much you owe in taxes.
What’s the Tax Rate For Capital Gains on the Sale of My Home?
If you find that the gains on your home sale are tax-free, hallelujah—you do not have to report them on your tax return.
For any remaining profits on the sale of your home that fall outside the exclusion, the capital gains tax will apply. The rate is 0%, 15%, or 20% dependent on your tax bracket.
You’ll need to report these gains on your annual tax return using Schedule D of IRS Form 1040. Failing to do so could result in an IRS sanction.
Thanks, Uncle Sam: Home Sale Profits Are Usually Tax Free
Homeownership is one of the best ways to increase wealth, and many taxpayers won’t have to pay a dime to the government on the sale of their home.
If you’re on the edge of possibly owing taxes on your gain, research your eligibility for the big breaks and carefully consider all of the capital improvements you’ve made over the course of ownership to lessen your tax burden.
Hopefully, in the end you can rest easy knowing that, come April, the money you made on the sale of your home isn’t going anywhere.
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