TAX PLANNING WHEN SELLING REAL ESTATE
If you are selling your primary home, the tax law allows you a very generous exclusion for the profit you have made. In fact, most home sales escape taxation altogether. So when you sell your home, you'll probably find packing up and unpacking in your new home to be a much harder task than calculating your income-tax bill from the sale. There's a good chance, in fact, that you won't even have to report the transaction to the IRS.
How Do I Figure the Profit?
From the net sales proceeds (that is the selling price minus the selling expenses, including the real estate agent's commission), subtract the adjusted tax basis in the home. Your adjusted basis is basically the original cost of the home plus the cost of capital improvements you've made, such as a new roof, a remodeled kitchen, a swimming pool or central air conditioning. If you sold a home before mid-1997 and rolled over profit from that sale into the home you just sold, your basis is reduced by the amount of that untaxed profit.
How Much Profit Can I Exclude from Income?
You can treat as tax free up to $500,000 of the profit from the sale if you're married filing jointly or up to $250,000 if you're single. (If you sold for a loss, you cannot deduct the loss.) You can use this exclusion every time you sell a primary residence, as long as you own and live in the home for two years and haven't sold used the exclusion to shelter profit from a home sale in the last two years. If the home-sale exclusion doesn't cover all your profit, the excess gain is reported on Schedule D with your other capital gains.
How Do I Qualify for Tax-Free Profit?
There are three tests you must meet in order to exclude the gain from the sale of your main home:
Ownership: You must have owned the home you are selling for at least two years during the five years prior to the sale.
Use: You must have used the home as your principal residence for at least two of the five years prior to the date of sale.
Timing: You must have not excluded the gain on the sale of another home within two years prior to this sale.
Also, if you are married:
You must file a joint return.
You or your spouse, but not necessarily both of you, must have owned the house for the requisite time.
You and your spouse must have lived in the house for the requisite time.
What if I Don't Fully Satisfy All the Tests for the Exclusion?
If you don't meet the ownership or use tests, your gain generally is taxed as short-term or long-term capital gain, depending on whether you owned the home for a year or less or more than one year, respectively. But there's a special rule that allows you to use a portion of the $250,000 or $500,000 exclusion if you needed to sell your home because of a change of employment, a change of health or other unforeseen circumstances, such as:
Multiple births from the same pregnancy
Broken engagement of a couple who jointly bought a home.
For example, assume you are single and sold your primary home one year after you bought it due to a job change. Say your profit was $30,000. Because you lived there for half the requisite period, you are entitled to half of the $250,000 exclusion, or $125,000. Thus, none of your $30,000 profit is taxed.
Do I Have to Report the Home Sale on my Return?
You generally do not need to report your home sale on your income tax return, as long as you did not receive a Form 1099-S, Proceeds from Real Estate Transactions, from the real estate closing agent (that is, a title company, real estate broker or mortgage company). To avoid getting this form, you must certify (usually at closing) that you meet the ownership, use and timing tests we noted earlier.
First-Time Homebuyer Credit
If you received the $7,500 first-time homebuyer credit for the purchase of a home in 2008, you must repay the credit by adding $500 each year to your tax bill — for 15 years — starting with your 2010 return. And, if you sell the home before the end of that 15 year period, you must repay any part of the credit that remands unpaid with the tax return for the year of the sale.
The $8,000 credit for first-time buyers and $6,500 credit for long-time residents who bought homes in 2009 and 2010 does not have to be repaid. Repayment was required if the home was sold within three years, but that period has passed. So, if you claimed that credit on your 2009 or 2010 tax return, and still own the house, then you are certain not to have to repay the credit when you sell.