By Darpan Patel
With mortgage rates near record lows and home prices soaring, you may be considering buying a new home and selling your existing home. Before you put your home up for sale, you should consider any tax implications to avoid any surprises. If you have owned the home for one year or less, the gain is taxed at your ordinary income tax rate. Otherwise, it is taxed at the more favorable capital gains tax rates. However, you may be able to exclude gain of up to $250,000 ($ 500,000 if filing as married filing jointly) if you meet the ownership and use tests discussed below.
- Ownership Test
To meet the ownership test, you must have owned your home for at least 2 years out of the last 5 years until the date of sale. For couples married filing jointly, only one spouse is required to own the home to meet the ownership test.
- Use Test
To meet the use test, you must meet the ownership test and have used the home as your primary residence for 2 years out of the previous 5 years. The 2 years do not have to be consecutive. As long as you’ve used it for 2 years (730 days) in the five year period as your primary residence you meet the use test. For couples married filing jointly, each spouse must have used the home as his/her primary residence for 2 years out of the previous 5 years.
- Exclusion of gain
As per IRC §121, you can exclude the gain (partially or all) from the sale of your home, if you meet both the ownership and use tests and avoid paying taxes on the gain to a certain amount. The maximum amount that can be excluded from your income is the first $250,000 of gain (or $500,000 if married couple filing jointly). Any gain in excess of the exclusion amount from the sale of your home is treated as a long term capital gain, given that you’ve owned the home for more than a year.
Other tax implications to worry about include tracking the cost basis of your home and realizing that a loss incurred from the sale of your home is not deductible as a loss on your income tax return. The cost basis of your home is the purchase price you paid, any closing costs on the purchase and sale, plus the cost of any improvements you made to the property. Maintaining thorough records of the improvements (invoices) and original purchase documents can help determine the accurate cost basis of the property. Additionally, if you used your primary residence for business purposes (home office or rental) there may be recapture of depreciation taken in prior years upon the sale.
If you are thinking of selling your home, you should speak with your CPA to determine if you are eligible for any gain exclusion and avoid any tax surprises.