Will you be selling your home in the near future? Tax season is right around the corner, so you may wonder how taxes work with home sales, especially if you have equity in your house.
Will Uncle Sam expect a share of the proceeds you receive for selling your home? It’s possible; however, most home sellers do not owe any taxes at close of escrow.
How Capital Gains Taxes Work for Real Estate Sales
When you sell stocks or bonds, or when you profit from an investment, the IRS generally requires you to pay a capital gains tax on the money you made. However, capital gains from home sales are treated differently, in that they are (at least partially) tax-exempt.
Typically, home sellers can take their proceeds without any tax obligation to the IRS — up to a point.
The amount of untaxed proceeds you can keep depends on your federal income tax filing status. If you file as single, you can profit up to $250,000 without paying taxes. For couples who file jointly, the amount increases to $500,000.
Capital Gains Tax Exemptions when Selling a Home
The U.S. federal tax code imparts some rules for real estate capital gains exemptions.
In order for you to be exempt from paying taxes when selling a home, the house must be your primary residence. In addition, you must have owned and lived in the home for at least two out of the last five years prior to its sale. Also, if you have claimed a home sale capital gains exemption on your income tax return within the last two years, you won’t be eligible this time.
Of course, based on the complexity and legal aspects of the tax code, we always recommend that you speak with your CPA or real estate attorney for expert advice on these issues.
Reducing Your Tax Burden When Selling Your Home
Even if you qualify for a capital gains tax exemption, you will likely owe taxes if your proceeds exceed the allowable limit.
For example, let’s say you are a single person who bought a house for $300,000 four years ago. This year, you sell your house for $600,000. Your $300,000 in proceeds will exceed the capital gains limit by $50,000. Consequently, the IRS will hold you liable for income taxes on that sum.
The good news: You may be able to avoid paying capital gains taxes if you have previously invested money into improving the property.
Let’s say that after purchasing your house, you spent $60,000 adding a new bathroom, finishing your basement, upgrading the wiring, replacing the roof or making other home improvements. All this work boosts the value of your home, but it also increases your overall cost to $360,000.
So when the house sells for $600,000, your proceeds are only $240,000. Thus you fall below the capital gains limit and shouldn’t owe any federal tax.
Are you ready to buy or sell property in Yorba Linda or the surrounding communities of Southern California? The Edie Israel Team provides expert real estate representation and a boutique level of customer service. Contact one of our experienced Realtors® today for assistance in buying or selling your home.