“I sold my house this year, am I required to pay taxes on the gain?”
This is a common question that we hear from our clients each year. The answer of course is the typical accountant answer: it depends. The majority of home sales will escape taxation altogether. To see if you are one of the lucky ones, follow these steps below:
Step 1: Calculate your gain on the home sale.
Gain = Sales Price - Basis
1) The sales price is reduced by selling expenses including realtor commissions
2) The basis is the amount you paid for the home plus any capital improvements you made such as remodeling, new garage, new roof, etc.
Example: Let’s suppose you sold your home for $500,000 and you paid your realtor $30,000 on the sale. Your net sales price in this instance would be $470,000. Let’s also suppose that you originally purchased the home for $350,000 and that you paid $50,000 to add on a garage. Your basis would be $400,000. The gain on the home sale would be the $470,000 net sales price less your $400,000 basis, or $70,000.
Step 2: Answer these three questions:
1) Did you own the home for at least 2 of the 5 years prior to sale?
2) Did you use the home as your main residence for at least 2 of the 5 years prior to sale?
3) Have you excluded the gain on the sale of another home within 2 years prior to sale?
Step 3: If you answered YES to questions #1 and #2, and NO to question #3, congratulations! You are eligible for the exclusion. The gain exclusion is $500,000 if you are married and $250,000 if you are single, so if the amount you calculated in Step 1 is less than these amounts, you owe no taxes on the sale.
If your home sale is excluded, you will not have to report your home sale on your tax return, unless you receive a 1099-S from the real estate closing agent. To avoid receiving a 1099-S, you must certify at closing that you will meet the exclusion requirements above.
NOTE 1: The home exclusion only applies to the sale of your main home. If you sell a second home or vacation home, you will have to pay capital gains taxes.
NOTE 2: There are certain “unforeseen circumstances” in which the IRS will allow you a partial gain exclusion on the sale of your home even if you do not meet the above circumstances. Read more here: Journal of Accountancy