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Taxes and Selling Your Home
General Business News
April 2000
Taxes and Selling Your Home
Some people buy a home and live in it for 20 years. Other people move every 2-5 years and need to understand the tax issues when looking at the contract the real estate broker has set in front of you. How long you live in that house makes a difference and you have to know the rules to avoid becoming the owner of a big tax bill. Understanding some of the rules now rather than after you move and it is tax time means money to you.
If you have owned your home and have lived in it for two of the previous five years, then you can make a profit of up to $250,000 if you are single and $500,000 if you are married, with no tax bill. These exclusions seem pretty high and not all of you live in real estate markets where you buy a house for $250,000 and change the wallpaper and sell it next year for $450,000. There are plenty of insane real estate markets around and Congress made these rules to fit some of you. Maybe you are just a really good homebuyer that is in the right place at the right time and have a habit of large profits on your home sales. Nevertheless, when selling your home, even getting a divorce or using a room in your house as an office can affect you at tax time.
When you calculate your gain on a home sale under today's rules, you must include the gains you rolled over into your current house. Let's say you have owned three homes over the past 20-years, and each went up in value by $100,000 during the time you owned it. You were lucky for one and two, you probably rolled the profits from one home into the next. This would mean you have $300,000 in accumulated gains. If you are single, the means you are going to have to pay taxes at the long-term capital gains rate most likely 20% on $50,000 of that profit. If you are married, you are probably sheltered by the $500,000 exemption for joint filers.
Publication 523 has worksheets for calculating the cost of your house for tax purposes, including increases from improvements and the exact amount of your gain. If you rolled over your prior gain, you will need to get out the tax return for the year of the last sale. In that tax return you should find Form 2119 (Sale of Your Home) which lists the cost basis of your current home, taking account any gains rolled over from previous residences. You take that amount and add the cost of subsequent improvements to arrive at the final cost basis for your current home.
Confused yet? You don't even know if you qualify for the tax break yet. If you owned your home and have used it as your principal residence for at least two years out of the five-year period ending on the sale date, you qualify. (The stories are endless of people who miss this opportunity because they missed the sale date by a month or less.) To claim the $500,000 joint return exemption, both you and your spouse must have used the home as your main residence for at least two years out of the five-year period.
Don't qualify? Waitâ¦
If you don't meet the above qualifications, wait and make sure before you give up. Did your job relocate you? If your boss moves you and you sell your home and make a profit of $100,000, you lived there for one-fourth of the two-year period required for a $500,000 gain exclusion, your maximum tax break would be $125,000, leaving you in the clear. This would apply even if you took advantage of the gain exclusion just six months ago when selling your last home. Make sure to give your tax professional all information you can about moving and see what options are out there for you.
Have a home office?
If you used 25% of your home as a deducted home office the entire time you live in the house and you make a profit of $100,000 when you sell, you have to pay taxes on the portion of your profit that came from the office or $25,000. Since you have deducted the home office, you have taken a depreciation deduction each year, which in this case would be approximately $5000, which adds to your gain. The $25,000 profit will be taxed at the maximum 20% rate for long-term capital gains, and the $5,000 will be taxed at a special 25% rate. Your total tax bill would be $6,250.
You could if you knew in advance you would be moving, give up the home-office deduction for two years. Then that portion of the house meets the two-out-of-five rule, and all of your profit will be tax-free, except the amount you deducted for depreciation after May 6, 1997.
Selling your home due to a death or divorce
You may be selling your home due for an unfortunate reason like death of a spouse or a divorce. If you should lose your spouse, you can file a joint return for that year, meaning you are safe if the profit is less than $500,000. After that year, the exclusion drops to $250,000. You might alter your selling plans when you take this into consideration. If you inherit your spouse's portion of your home, your basis on that piece is stepped up to the market value as of the date of death. Your gain may not be as big as you thought.
If you sell your home before you divorce, you get the $500,000 exemption as long as you are filing a joint return. If one spouse takes ownership after the divorce, the limit again will fall to $250,000. If you continue to own a home with a former spouse, the best advice is to have it spelled out in your divorce decree who will live in the house and talk to a professional on how to word this to make sure everyone understands who gets what exclusions.
After you sell your home, you are stuck with what you have but there are rules on home sales that might help in timing your next move. Unfortunately you can't sell your home and keep all the money. The more information you give your financial professional, the better job he or she can do for you. Discussing matters before you sell or terminate a marriage or even look at that contract on your home can be financially profitable. Information as simple as moving due to health reasons can make a difference to your CPA. Sometimes even taking a few thousand dollars less for your home can help you keep more of your money in the long run.
If you have owned your home and have lived in it for two of the previous five years, then you can make a profit of up to $250,000 if you are single and $500,000 if you are married, with no tax bill. These exclusions seem pretty high and not all of you live in real estate markets where you buy a house for $250,000 and change the wallpaper and sell it next year for $450,000. There are plenty of insane real estate markets around and Congress made these rules to fit some of you. Maybe you are just a really good homebuyer that is in the right place at the right time and have a habit of large profits on your home sales. Nevertheless, when selling your home, even getting a divorce or using a room in your house as an office can affect you at tax time.
When you calculate your gain on a home sale under today's rules, you must include the gains you rolled over into your current house. Let's say you have owned three homes over the past 20-years, and each went up in value by $100,000 during the time you owned it. You were lucky for one and two, you probably rolled the profits from one home into the next. This would mean you have $300,000 in accumulated gains. If you are single, the means you are going to have to pay taxes at the long-term capital gains rate most likely 20% on $50,000 of that profit. If you are married, you are probably sheltered by the $500,000 exemption for joint filers.
Publication 523 has worksheets for calculating the cost of your house for tax purposes, including increases from improvements and the exact amount of your gain. If you rolled over your prior gain, you will need to get out the tax return for the year of the last sale. In that tax return you should find Form 2119 (Sale of Your Home) which lists the cost basis of your current home, taking account any gains rolled over from previous residences. You take that amount and add the cost of subsequent improvements to arrive at the final cost basis for your current home.
Confused yet? You don't even know if you qualify for the tax break yet. If you owned your home and have used it as your principal residence for at least two years out of the five-year period ending on the sale date, you qualify. (The stories are endless of people who miss this opportunity because they missed the sale date by a month or less.) To claim the $500,000 joint return exemption, both you and your spouse must have used the home as your main residence for at least two years out of the five-year period.
Don't qualify? Waitâ¦
If you don't meet the above qualifications, wait and make sure before you give up. Did your job relocate you? If your boss moves you and you sell your home and make a profit of $100,000, you lived there for one-fourth of the two-year period required for a $500,000 gain exclusion, your maximum tax break would be $125,000, leaving you in the clear. This would apply even if you took advantage of the gain exclusion just six months ago when selling your last home. Make sure to give your tax professional all information you can about moving and see what options are out there for you.
Have a home office?
If you used 25% of your home as a deducted home office the entire time you live in the house and you make a profit of $100,000 when you sell, you have to pay taxes on the portion of your profit that came from the office or $25,000. Since you have deducted the home office, you have taken a depreciation deduction each year, which in this case would be approximately $5000, which adds to your gain. The $25,000 profit will be taxed at the maximum 20% rate for long-term capital gains, and the $5,000 will be taxed at a special 25% rate. Your total tax bill would be $6,250.
You could if you knew in advance you would be moving, give up the home-office deduction for two years. Then that portion of the house meets the two-out-of-five rule, and all of your profit will be tax-free, except the amount you deducted for depreciation after May 6, 1997.
Selling your home due to a death or divorce
You may be selling your home due for an unfortunate reason like death of a spouse or a divorce. If you should lose your spouse, you can file a joint return for that year, meaning you are safe if the profit is less than $500,000. After that year, the exclusion drops to $250,000. You might alter your selling plans when you take this into consideration. If you inherit your spouse's portion of your home, your basis on that piece is stepped up to the market value as of the date of death. Your gain may not be as big as you thought.
If you sell your home before you divorce, you get the $500,000 exemption as long as you are filing a joint return. If one spouse takes ownership after the divorce, the limit again will fall to $250,000. If you continue to own a home with a former spouse, the best advice is to have it spelled out in your divorce decree who will live in the house and talk to a professional on how to word this to make sure everyone understands who gets what exclusions.
After you sell your home, you are stuck with what you have but there are rules on home sales that might help in timing your next move. Unfortunately you can't sell your home and keep all the money. The more information you give your financial professional, the better job he or she can do for you. Discussing matters before you sell or terminate a marriage or even look at that contract on your home can be financially profitable. Information as simple as moving due to health reasons can make a difference to your CPA. Sometimes even taking a few thousand dollars less for your home can help you keep more of your money in the long run.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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