Whenever you’re selling property or investments that have appreciated in value, taxes are a big consideration in the timing of the sale. Selling at the wrong time can lead to a higher tax bill, whereas waiting for the right time can ease your tax burden significantly. This is especially true when it comes to the sale of your primary residence.
Calculating the gain
The first step in determining the taxability of the sale of your home is to determine how much of the sale is capital gain. To determine this, you must subtract the cost of the house from the sales price. Keep in mind that the total cost of your house includes not only how much you originally paid for it but also costs for any additions or improvements, as well as some of the fees associated with its purchase and sale. In addition, some things can reduce the cost basis in your home such as deprecation if you used part of your home for business or rental purposes or reimbursements from homeowners insurance for repairing damage. Consult with a tax adviser to discuss what costs are included and which are not. Once the total cost basis is calculated, this amount is deducted from the sales proceeds to calculate the capital gain to report to the IRS.
$60,000 home purchase in 1965
$25,000 addition added in 2010
$85,000 cost basis
$400,000 Sales price in 2016
$30,000 Selling costs including real estate commissions and some closing fees
$370,000 sale proceeds
$370,000 sales proceeds
$85,000 cost basis
$285,000 capital gain
Note that if you inherited the property from someone after they died, your cost basis becomes the value of the property as of the decedent’s date of death. If you were given the property while someone was still alive, you take over the original cost basis of the person that gave it to you. See our blog “Gifting Away Tax Benefits” for more details.
Tax Exemption Up for Grabs
When you sell your primary residence you can actually qualify for significant tax exclusions. Each owner may be able to exclude as much as $250,000 in gains, which means joint owners may be able to exclude as much as $500,000 ($250,000 per person). In the example above, a single person would have only had to pay tax on $35,000 after the $250,000 exemption but a couple jointly owning the home would not have to pay any tax at all since they can exempt a total of $500,000.
Qualifying for the Tax Exemption
The IRS only allows these exclusions if you sell a home that you owned and lived in as a primary residence for at least two years out of the last five before the sale. This means you could still qualify for the exclusion if you sell the house within three years of moving out of it because you will have lived in it the first two years of the last five years.
If you have a disability and are unable to independently care for yourself, this requirement is shortened to 1 year out of the last 5.
At Kramer Wealth Managers, we know the importance of finding all the tax breaks you can take in order to preserve and grow your savings and stay on the right track to your WealthPath. Contact us today to find out how we can help you.
While the tax or legal information provided is based on our understanding of current laws, this information is not intended as tax or legal advice and should not be relied upon as tax or legal advice. Federal tax laws are complex and subject to change. Neither FSC Securities Corporation, nor its registered representatives, provide tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.