Buying low and selling high is generally the best choice, and it’s thrilling to turn a big profit on the sale of a home. But don’t overestimate your profit by forgetting to take into consideration taxes. For some homeowners, a big profit at closing can generally mean a pretty large tax bill.
Regardless, not everyone will owe taxes for the sale of their home — there are a good amount of exceptions and personal circumstances that will impact your tax liability. Usually, there are three types of taxes to think about when selling your home:
- Capital gains tax
- Property tax
- Real estate transfer tax
If I Sell My House, Do I Pay Capital Gains Tax?
Some homeowners will owe capital gains tax on selling a home if they simply don’t qualify for an exclusion or special circumstance. Generally speaking, it’s easier to minimize or eliminate capital gains taxes on a primary home than a vacation or rental property.
Do keep in mind that even if you qualify for a capital gains tax exclusion, you can’t qualify for another exclusion for at least two years.
Capital Gains Tax Exemption
Many homeowners avoid capital gains taxes when selling their primary home, but there are a few things to consider. First, you must have lived in the home for at least two of the last five years of ownership. And the profits are taxable if they go over $250,000 for single filers or $500,000 for joint/married filers.
When it comes to married couples filing jointly, most experienced real estate agents will tell you that you must file a joint tax return, and one spouse needs to have owned the property for a minimum of five years, with both spouses living in the house for two of the last five years.
If your profits do go over the exemption amounts, here’s the rate you can expect to pay on any profits above $250,000/$500,000. These rates put into consideration that you have owned the home for at least a year. If you have owned for less than a year, you’ll be taxed on the gains at your regular income tax rate.
Other Capital Gains Tax Rules
If you don’t qualify for the tax exclusion above, consider one of the other special considerations the IRS allows for when calculating capital gains taxes.
Divorce: If you acquired the home in a divorce, you can use the time your ex-spouse lived in the home as their primary residence toward the residency requirements.
Death: If one spouse dies, you can count the time the deceased person lived in the home to qualify for the exclusion, as long as you didn’t remarry.
Qualified official extended duty: If you work for a military or government intelligence agency and were stationed 50-plus miles from home or living in required government housing, you can get the two-year minimum waived.
Can I qualify for a partial capital gains tax exclusion?
Even if you can’t exclude all of your home sale profit, there are other scenarios where you may be able to partially lower your taxable profit. Our real estate agents say if you experienced any of the below life events, you may be able to get a partial exclusion, calculated based on the percent of the two years that you lived in the home.
- Job change/relocation
- Health issue that requires moving
- Having twins or triplets
How Do I Know If I Owe Capital Gains Taxes On Selling My Home?
Generally, anyone who receives a Form 1099-S: Proceeds from Real Estate Transactions at closing will owe some sort of capital gains tax on their home sale and will be required to file home sale profits on their tax return. A copy of the 1099-S is sent to the IRS too.
If you receive a Form 1099-S and believe you could qualify for any capital gains tax exclusions, talk to a pro before closing, such as your real estate agent or attorney, so you can avoid having the form filed. If you receive the form in error, be certain you can document how you qualify, and talk to your accountant or attorney about how to handle reporting the home sale on your taxes.
Will I Owe Taxes On selling A Second House?
The above capital gains exclusions apply only to main residences, so any second home or investment property will be subject to capital gains taxes, at any amount of profit. But there are a few things you can do to bring down the burden.
Convert the Home to a Primary Residence
Move into the second home or rental property. By making it your main residence, in two years you’ll be able to sell while taking advantage of capital gains exclusions.
Do an IRS Section 1031 exchange
A 1031 exchange allows you to roll over profits from a second home sale into another investment property within 90 days of selling and defer capital gains tax liability. This is a complicated process that requires an intermediary to manage the rollover, and you’re required to follow specific guidelines.
For example, 1031 exchanges are only available on rental properties (not primary homes or vacation properties), so if you want to take advantage of this tax-deferred exchange, you’ll need to convert the property to a rental property first. And you’re limited to doing one 1031 exchange every five years.
If you’re interested in doing a 1031 exchange, talk to your real estate agent, tax professional and attorney before anything else.
Report Losses to Offset Profits
Our realtors suggest you report other capital losses you’ve had in the same tax year to offset your capital gains.
Learn How to Calculate Capital Gains Tax
If you won’t qualify for any capital gains tax exemptions, it’s best to know how much you’ll owe ahead of time so you have a better idea of your final profit. Here’s how to calculate it.
Figure Out Your Cost Basis
Your cost basis is the original purchase price of your home, plus any money you’ve spent on improvements that you did not previously deduct for tax purposes.
If you converted a rental property into your primary residence, your basis would be the lower of your original purchase price or the fair market value of the home on the date you converted its use. You will still increase the basis by any money spent on improvements.