What happens with profit from the sale of a home?

Whether or not you must pay taxes on your profit and how much of that profit is taxable depends on how long you have owned the home, whether or not you are married, and how much money you made on the sale. (Unfortunately, if you sell the home at a loss, you cannot deduct that amount.)

You can exclude up to $250,000 (or $500,000 if married) from capital gains tax if:

  • You have owned the home you are selling for at least two years, whether continuous or noncontinuous, during the five years ending on the date of the sale,
  • The home has been your principal residence (or the single main home where you ordinarily live most of the time) for at least two years during the same period, and
  • You did not exclude gain from the sale of another home during that time.

If you are part of a married couple and you and your spouse both satisfy all requirements outlined above and file a joint return for the year, the exclusion doubles to $500,000 of profit. Even if one of you does not meet all the requirements, you can still exclude the total of exclusions that each of you would qualify for if you were not married.

That sounds like great news, but there is a catch. The higher your profit, the less significant those exclusions become. The $250,000 and $500,000 thresholds have not been updated since 1997, while median home sale prices have skyrocketed in that time.

If you are a long-term homeowner and the value of your home has risen dramatically, this may leave you in a frustrating position.  For example, if you are single and you sell your home for $250,000 in profit, you can exclude 100% of your profit from capital gains taxes. On the other hand, if you make $1,000,000 in profit, you must still adhere to the same limit, meaning you can only write off 25% of your profit, or $250,000.

That said, there are still ways for sellers in such a position to lower their taxable profits.

How can I avoid capital gains tax on a home sale?

If your sale price exceeds the exemptions, one way to reduce taxation on your profits is by reducing the profits themselves. You can accomplish this by increasing the property basis — generally defined as the amount of your capital investment in the property for tax purposes. To put it another way: the cost to you.

Therefore, you may be able to add improvements to the property such as additions, landscaping, insulation, plumbing, and more to the original purchase price, thus increasing basis and lowering your taxable profits.

If the property is not your primary residence, but is instead an investment or business owned property, you may be able to postpone capital gains through a 1031 exchange.

Essentially, instead of selling a property for capital in this type of transaction, you trade it in exchange for another qualifying property. Generally, when you make a like-kind exchange, you can defer recognizing any gains or losses on your tax returns until you sell or dispose of the property received. However you can only do this for investment properties.

We dove deeper into like-kind exchanges in a recent blog post, which you can read by clicking here.

Is the sale of a house reported to the IRS?

If your profits are less than or equal to the applicable exclusion limit, you do not have to report the sale of your home to the IRS.

However, you must report the sale using Form 8949, Sale and Other Dispositions of Capital Assets, if:

If you do receive a Form 1099-S or other informational income-reporting document, you must report the sale even if your profits are eligible for total exclusion.

To learn more about the rules on reporting your sale on your income tax return, refer to Publication 523.

Special circumstances

We’ll conclude with some more good news: If you do not meet the previously outlined ownership and residence requirements, there are special circumstances in which you may nevertheless qualify for a full or partial exclusion.

For example:

  • Surviving spouse: If you are a surviving spouse who has not remarried before the sale of a home, the IRS considers you to have owned and used the home as a primary residence during the deceased spouse’s ownership and use period.
  • Home transferred from spouse: If you acquire a home in a transfer from your spouse (or former spouse if the transfer was incident to divorce), the IRS considers you to have owned the home during any period of time your spouse (or former spouse) owned it.
  • Divorced individuals: The IRS considers you to have used a home as a principal residence during any period when:
    • You owned the home, and
    • Your spouse or former spouse is allowed to live in it under a divorce or separation instrument and uses the home as a principal residence.
  • Inherited home: If you inherit a home, you are generally not eligible for gain exclusion unless you meet the ownership and use tests for the inherited home.

In certain qualifying circumstances, you may also be able to claim a partial exclusion if the primary reason for the sale is due to a change in employment, health, or unforeseen circumstances.

The bottom line

If you are considering selling your home, you no doubt have a lot on your mind. It’s a complex undertaking — but that is precisely why it’s so important to make sure you have considered all the tax implications.

Of course, the best way to avoid an unpleasant surprise at tax time is to seek the counsel of professional tax experts (like us).

Would you like some help?

If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 or contact us here to set up a time.

If you aren’t a client, why not? We can take care of your accounting, bookkeeping, tax, and CFO needs so that you don’t have to worry about any of them. Interested? Contact us here to set up a no-obligation consultation.

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