Selling a home can be a huge financial decision with numerous factors to consider, one of the most important factors being the tax implications. While most might be eager to make a huge profit from selling their home, it is critical to understand the tax rules and regulations that apply to this transaction in order to be prepared and make informed decisions. In this post, we will look at the primary tax implications of selling a home, such as potential capital gains taxes and exemptions, as well as crucial homeowner concerns.
What are capital gains taxes?
Some may be shocked to learn that not every home sale needs to be reported to the IRS. That said, if you’re not exempt from reporting your home sale to the IRS, the potential capital gains tax is one of the most important tax implications to worry about. Capital gains taxes are taxes paid on the profit made when an investment is sold. These investments can include stocks, bonds, NFTs, jewelry, and of course real estate. Capital gains taxes are extremely complex. Therefore, in this article, we will only be focusing on the capital gains taxes paid after the sale of a home.
Do I have to pay taxes on the profit I made from a home sale?
Whether or not you’ll have to pay taxes on the profit you earned from the sale of your home will depend on two factors: how much profit you earned and how long you owned and lived in the home before the sale.
If you owned and lived in the home for at least two of five years before its sale, you may exclude up to $250,000 of the profit from your taxable income, or $500,000 if you are married filing jointly. If your profit exceeds the limit ($250,000 or $500,000 for married couples filing jointly), then the excess will be subject to capital gains taxes reported on Schedule D.
There are some important things to note when determining your eligibility for this tax break. While you do need to live in the home for two years out of five before its sale, those two years do not need to be consecutive. That said, the home must have been your primary residence for two years out of the five prior to selling it. Finally, you can only exclude this profit from your taxable income if you have not excluded the gain on the sale of another home within two years before this sale.
How does capital gains tax work in the sale of real estate?
Let’s look at a few scenarios on how to calculate capital gains tax. Assume you as a single filer purchased a townhome for $350,000 and used it as your primary residence for five years. After five years, you decided to sell the home for $450,000. No capital gains tax would be due because the profit of $100,000 does not exceed the single filer’s exempt amount of $150,000.
Here’s another example. Assume you are a single filer who purchased a home for $400,000. After living in the home for two years, you decide to rent it out. Three years pass and you decide to sell the house for $550,000. Because you lived in the home for two of the previous five years and because the profit earned on the house does not exceed the $150,000 exempt amount, no capital gains tax is owed.
Now let’s assume you and your spouse file jointly. You purchase a home for $300,000 and many years later you decide to downsize. You sell your home for $1 million, earning a profit of $700,000. Since this amount exceeds the exempt amount of $500,000 for married couples filing jointly, you and your spouse will owe capital gains tax on the excess amount of $200,000 ($700,000 – $500,000). Your capital gains rate will depend on your taxable income in the year the home is sold. In 2023, these rates are:
|Filing Status||0% Tax Rate||15% Tax Rate||20% Tax Rate|
|Single||Up to $44,625 in taxable income||$44,626 to $492,300 in taxable income||Over $492,300 in taxable income|
|Head of Household||Up to $59,750||$59,751 to $523,050||Over $523,050|
|Married Filing Jointly and Surviving Spouses||Up to $89,250||$89,251 to $553,850||Over $553,850|
|Married Filing Separately||Up to $44,625||$44,626 to $276,900||Over $276,900|
Let’s assume that same couple had a combined income of $300,000 in 2023, the year their house was sold. This would subject them to the 15% capital gains tax rate. This would then result in $30,000 in capital gains tax due (15% of $200,000 profit).
How do I figure out my actual gain or loss on a home sale?
While the above scenarios are helpful in understanding how capital gains tax works, these really are the simplest of examples. Finding out the actual cost of your home and actual gain or loss can quickly become a complex task. Determining your actual cost involves calculating the amount invested into the home through capital investments, like a new roof, updated HVAC, or a remodeled bathroom. Adding these expenses, along with any special tax assessments paid or expenses paid to restore damage after a disaster, to your purchase price will give you what’s called your adjusted basis. Your adjusted basis will help you decrease the amount of gain on the sale since it can increase the cost of your home.
From there, you will need to subtract credits received from your home. These can include:
- Energy efficiency credits
- Insurance reimbursements
- Casualty losses from disasters or accidents
- First-time homebuyer credits
After factoring in all these costs and credits, you’ll be able to figure out the adjusted basis that can be subtracted from your sale price to find your actual gain or loss.
Tax Help for Homeowners
It goes without saying that selling a home can be a very complex process, especially when factoring in the tax implications that can follow. If you are not familiar with the tax implications of selling a home, especially at a large profit, it is highly advisable to reach out to a qualified tax professional. Taking a chance and handling things on your own can quickly result in costly errors on your tax return and unwanted encounters with the IRS. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
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