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DISCLAIMER: This article is intended for educational purposes only, not legal or tax advice. If you need help determining the tax implications of selling a home, please consult a skilled tax professional.
You’ve just sold your home for a profit — way to go! — and now perhaps you find yourself wondering what happens next, especially when tax time comes around. Maybe you’re already sitting down to work on taxes, and you’re worried about how much that profit you made last year will end up costing you. Or maybe you’re just pondering selling because you know you could make a great profit in this market, but you’re curious about how complicated that would make taxes.
Wherever you are in your home-selling or tax-prep journey at the moment, we’ll review how your taxes may be impacted by selling your home for a profit. We’ll discuss the capital gains tax, how you may be excluded from it, and what may be different for you if you’re selling an inherited property or relocating for the military. Lastly, we’ll point you to some forms and key resources to help along the way.
Capital gains tax implications of selling a home
The biggest question at tax time for someone who recently sold a home is whether they’ll have to pay federal capital gains taxes on the profit. In short, capital gains are the amount of money you make from selling capital assets — property like homes, cars, investments, and other high-value items.
In recent years, home prices have increased dramatically. Therefore, many homeowners looking to sell in 2024 will have experienced significant capital gains since their home purchase, especially if they’ve owned their home for more than three years. For 2024, the IRS announced some rule changes on capital gains. The tax rates remain the same, but the income thresholds for those rates are moving slightly higher, with an approximate 5.4% increase from 2023 levels.
According to Allec, if you sold a home last year, you may receive a 1099-S in the mail from the escrow company. “The thing to keep in mind is that the number on that 1099-S is not necessarily taxable,” Allec adds. “For one thing, the amount on that form is the gross proceeds, not net proceeds.”
To determine net proceeds, Allec says people must take time to calculate the basis of their home. Basis is tax-speak for what your home has cost you, and despite what you might think, it’s not just the purchase price. “Your basis is probably actually more than that,” Allec explains. “Escrow fees, recording fees, appraisal fees — all that stuff, you can add to your basis in your home.” In other words, make sure you account for all the costs associated with selling your home when you’re calculating net profit.
You should also take into account the costs of major or “capital” improvements you made to your home, but keep in mind that simple repairs and maintenance don’t necessarily increase the basis. Allec says, “If something broke in your home — like some fixture or something — and you’re just returning it to its original condition, you can’t count that. But let’s say you add a whole new bedroom — that adds to your basis.”
For examples of more improvements that add to your home’s basis, check out page 9 of IRS Publication 523.
Another way to make sure you don’t overestimate your profit from the home sale is to take into account all the selling expenses, as well. Make sure you subtract from your net profit things like the real estate broker’s commission and any other closing costs you paid.
Let’s look at the impact of calculating gross vs. net profit in a hypothetical example:
- You paid $350,000 for your home 10 years ago and paid $10,000 in closing costs.
- Five years ago, you spent $20,000 to construct an addition onto the house.
- Now, you sold your home for $500,000, with $40,000 in closing costs.
- If you only calculate gross profit (selling price minus the purchase price 10 years ago), you gained $150,000.
- Accounting for your buying costs 10 years ago, plus the capital improvements you made, your basis in the house is $380,000.
- To calculate net profit, you would subtract that $380,000 from the $500,000 sales price, then also subtract your $40,000 in selling costs. That leaves you with a net taxable gain on the sale of $80,000 — compared with a gross profit of $150,000.
As you can see, taking the time to make these calculations can make a significant difference.
Capital gains exclusions
Fortunately, many home sales qualify for the Exclusion of Gain exemption. This means that when certain conditions are met, sellers can exclude up to $250,000 (for a single person) or $500,000 (married, filing jointly) of their profit from a home sale.
Let’s take a look at when the exclusion does and does not apply.
When does the exclusion apply?
There are three conditions that must be met in order to use the $250,000 or $500,000 exclusion to avoid paying any capital gains taxes on the sale of a home:
- Ownership test. You need to have owned the home for at least 2 of the last 5 years.
- Use (or residency) test. You must have lived in the house as your primary residence for a total of at least 2 of the last 5 years, even if those 2 years were not continuous.
- Timing (or look-back) test. You must not have already taken advantage of this tax exclusion for another home in the last 2 years.
To qualify for the $500,000 exclusion:
- You must be married.
- You must file your taxes as married-filing-jointly.
- At least one spouse has to pass the ownership test.
- Both spouses must pass the use test.
When does the exclusion not apply?
Capital gains tax exclusion cannot apply when:
- Selling a second home (whether a personal vacation property or rental)
- You’ve lived in the home for less than 2 of the last 5 years
- You acquired the property through what is called a “like-kind exchange” in the past 5 years
- You are subject to the expatriate tax
Whether or not the exclusion applies to you, here are more tips for offsetting the capital gains on your home sale.
What about special circumstances?
Even if you don’t pass the ownership and use tests, you may still qualify for the exclusion or a partial exclusion under certain special circumstances, such as:
- Divorce or a separation agreement
- Death of a spouse
- Job change
- Certain extended duties away from the home as a result of serving in the uniformed services (more on this below), foreign service, or intelligence services
Sometimes even unexpected health or family changes can justify a partial exclusion. Allec recounts, “One client already had three children, and then they had triplets, and we argued that their home was too small. We got a proration for that, and it was not challenged by the IRS.”
For more on special circumstances, consult the IRS guide, “Tax considerations when selling a home.” If you use a tax preparation service like TurboTax, H&R Block, or Jackson Hewitt, these companies also have guides to assist you.
Selling an inherited property
What happens if you’re selling a property that you inherited?
- Thankfully, there are no federal inheritance taxes requiring you to pay on an inherited property at the time it becomes yours. (Note that, according to Policygenius, there are six states with inheritance taxes.)
- When you go to sell the inherited property, however, you will be subject to capital gains taxes based on the amount that the inherited property has increased in value since it became yours.
- The IRS uses what’s called a “stepped-up basis” to calculate capital gains on the sale of an inherited property, which ultimately helps reduce your taxes.
- So, for example, if you inherit a house that was worth $200,000 when you acquired it, and 5 years later, you sell it for $300,000, you could pay capital gains taxes on $100,000 of that sale.
Note: Receiving a house as a gift is very different for tax purposes than receiving one as an inheritance, Allec says: “Your basis in the home is generally the same as the person’s who gifted it to you was.”
Relocating for the military
There are some special rules for the armed forces.
Capital gains exclusion for the military
The IRS outlines some different situations in which members of the armed forces can still receive full or partial exclusion even when they don’t fully “pass” all the tests:
- As a starting point, the same rules about the capital gains on the home sale apply — excluding $250,000 or $500,000 of gain from selling a primary residence that passes the usual tests we’ve already discussed.
- However, if you’re relocated to a new permanent duty station — preventing you from passing the ownership and use tests — you can still qualify for a reduced exclusion.
- You may also be eligible to “stop the clock” — or, more technically, choose to “suspend” the 5-year “test period” that would normally be used to evaluate whether a house has been your primary residence. This may apply to you if you have been on “qualified official extended duty” preventing you from living in the house for 2 years within the last 5 years.
For an example of how a suspension plays out and more details about capital gains taxes for armed service members, check out pages 18 and 19 of the IRS Armed Forces Tax Guide.
Writing off moving expenses
Capital gains aside for a moment, there may be a bonus for members of the armed forces. If you’re selling your home because you’ve been permanently relocated due to a military order, a significant portion of your moving costs may be tax-deductible.
According to IRS Publication 3, you can deduct:
- Transportation and storage of household goods and personal items
- Travel from your old home to your new home (including lodging, to an extent)
Take note, however, that food will not be deductible.
State and local taxes
Most states also tax capital gains. Currently, only 8 states do not tax capital gains:
- New Hampshire
- South Dakota
While specific rules vary, if you live elsewhere in the U.S., the profit on your home sale may be taxable at the state level. You can check your state’s capital gains tax rate here.
If you sold your home in a high-tax state like California or New York and are also in a high tax bracket, says Allec, “you probably want to talk to a professional” to help you file. A tax professional may be able to help you mitigate your tax burden, plus take into account any local taxes that may apply, as well.
More forms and resources
- For a starting point on what documents you’ll need for filing taxes after selling a house, see this HomeLight link.
- If you receive a 1099-S in the mail, you must report the sale of your home to the IRS — even if you qualify for full exclusion of gains. You’ll need to complete Schedule D (Form 1040), Capital Gains and Losses, and Form 8949, Sales and other Dispositions of Capital Assets.
- If you’re a member of the armed forces moving because of reassignment and writing off moving expenses, use Form 3909. And the IRS Armed Forces’ Tax Guide contains all the official details.
- For more detailed information from the IRS about selling your home, refer to IRS Publication 523.
When to talk to a professional about property-related taxes
“If you’re selling a home and you clearly don’t qualify for that home sale exclusion,” recommends Allec, “it’s probably a good idea to reach out for help.” Or, depending on your specific situation, you might have more questions.
Rather than talking to your real estate agent, it’s a good idea to go to an accountant or attorney with specific questions, including:
- Questions about estate taxes or what will happen if/when the property owner dies (in this case, you’d talk to an estate planning attorney instead of a tax attorney)
- How to structure the ownership of the property — perhaps you want to put it in the name of an estate, trust, or company, as opposed to your personal name
- Buying a property in the US, when you aren’t a US resident or citizen
Your real estate agent may be able to refer you to the appropriate professional to help navigate the tax implications of selling a home, depending on your specific scenario and questions. Don’t have an agent? HomeLight can connect you to a top-performing, trusted agent in your market.
Header Image Source: (rawpixel / Unsplash)
- "Heads up investors: Capital-gains tax rules for 2024 are here," MSN, Andrew Keshner (November 2023)
- "State-by-state guide to inheritance taxes," Policygenius, Derek Silva (January 2023)
- "Capital Gains Rules for Military Families," Veteran.com (April 2022)
- "States With Low and No Capital Gains Tax," Kiplinger, Kelley R. Taylor (September 2023)
- "2023 Capital Gains Tax Rates by State," smartasset, Nadia Ahmad, CEPF® (March 2023)