Selling your home? One of the benefits of our current tax system is the ability of some home sales to result in a tax-free profit for the seller. Typically, taxes are handled entirely at the time of closing between buyer and seller, and more often than not your home sale may not even have to be reported to the IRS. Even without reporting requirements, if your home sale profit exceeds certain limits, knowing the various nuances of home sale regulations can effectively decrease your tax liabilities and potentially increase your savings. So, whether you’re a case of exception or not, it helps to understand the rules governing home sales.
CAPITAL GAINS
If you sell your house for more than it cost, then the profit you’ve made on the sale is considered a capital gain. For tax purposes, you’d need to determine your original cost basis versus your adjusted basis in order to know whether you’ve gained or lost on the sale.
ORIGINAL BASIS
The original basis, in most cases, is the amount you originally paid for the home. If you built your home, then your basis is the original cost of the land plus the amount it cost you to construct the home. If you inherited your home as a result of someone’s death (in any year except 2010), your basis is the fair market value of the home on the date of the previous owner’s death; or, on the alternate valuation date if the executor of the estate elected to value the estate’s assets as of six months after the owner’s death. Please note that special basis rules apply if the death occurred in 2010.
ADJUSTED BASIS
The adjusted basis is what you’ve invested in the home–in other words, the original cost plus the cost of certain capital improvements you’ve made. Examples of capital improvements include but are not limited to a new roof, remodeling of a room (i.e. the kitchen), installation of a swimming pool, and central air conditioning. These expenses are added on to your original cost basis (less the costs of maintenance and repairs) to get to the increased adjusted basis. You should be aware, however, that not all costs associated with “home improvements” and maintenance necessary to keep your home in good condition prior to its sale would count toward your adjusted basis. Any improvements that are no longer considered part of your home (i.e. wall-to-wall carpeting that you installed but later removed or replaced), or any “improvement” costs with a life expectancy of less than one year, cannot be included in your basis.
Costs initially attributed to the seller that the buyer has taken on and paid can typically be included in the buyer’s basis (as long as the buyer was not reimbursed by the seller for these expenses). Examples include real estate taxes owned through the date of home ownership prior to the sale date, the seller’s title recording or mortgage fees.
Additionally, any depreciation, casualty losses or energy credits that you have claimed to reduce your tax bills in prior years while you’ve owned the house would need to be subtracted from your basis.
QUALIFYING FOR THE EXCLUSION OF GAIN
The maximum exclusion of the gain from a home sale allowed by the tax code is $250,000 (single individual) or $500,000 (married filing jointly). In order to qualify for the tax exclusion, you must meet the eligibility test which includes the following criteria:
1. Ownership Requirement – If you owned your home for at least 2 of the last 5 years up to the date of the sale, you would meet the ownership requirement. Only a “main” home qualifies (that being the home in which a taxpayer has lived in for the majority of time during a given tax year). For married couples, it is only necessary for one spouse to meet the ownership requirement.
2. Residency Requirement – If you owned your home for at least 2 years of the 5-year period, you would meet the residency requirement. Unlike the ownership requirement test, each spouse must meet the residency requirement in order to get the full exclusion when filing married jointly.
3. Look-Back Requirement – You may only take the home sale tax exclusion after a 2-year residency period in the home. You can use this exclusion every time you sell a primary residence, as long as you owned and lived in it for 2 of the 5 years leading to the sale, and have not claimed the exclusion on another home in the last two years.
If you meet the ownership, residency and look-back requirements, taking exceptions into account, then you would meet the eligibility test; and your home sale would qualify for the maximum exclusion.
REPORTING THE SALE OF YOUR HOME
You generally need to report the sale of your home on your tax return if you meet any of the below requirements for excluding the gain on the sale of your home:
1. You have a taxable gain on your home sale
2. You have received a Form 1099-S (even if you don’t have a taxable gain to report)
3. You wish to report your gain as a taxable gain (even though some or all of it is not eligible for exclusion)
The IRS does not require the real estate agent who closes on the sale to use Form 1099-S to report the sales amounting to $250,000 or less ($500,000 or less for married couples filing jointly). In order to avoid receiving this form for your sale and having a copy sent to the IRS (if you meet these sale maximums), you must give your agent some assurance that all profit on the sale is tax-free. (To do so, you would need to confirm for the agent that you qualify for the exclusion of the gain from the sale of your home.)
HOME SOLD AT A LOSS
Keep in mind that if you sell your main home at a loss, you cannot deduct the loss on your tax return. Tax losses can generally only be claimed on property sales used for investment purposes.
PLANNING AHEAD
While profit is typically one of the primary concerns when it comes to selling a home, knowing the various regulations and requirements that apply to you in a home sale will help you ensure that you’re taking all the right steps to decrease or eliminate your tax liabilities as they relate to the sale. For example, if you have a taxable gain on the sale of your home, you may either be obligated to increase your tax withholding amount or pay quarterly estimated taxes. It is always recommended that you discuss any potential home sales or purchases with your trusted financial and/or tax advisor well in advance of the proposed transaction so that you fully understand your responsibilities.
This blog series is meant to provide an overview of the common implications you might face when you encounter various life events, but there are likely additional considerations dependent on your specific scenario. Here at FF&F our experienced staff will act as your advisors throughout each step of any event that might affect your tax planning. For more information on this topic, or to discuss tax planning strategies, please contact us at info@fffcpas.com or (212) 245-5900.
Click here for the full IRS publication, “Selling Your Home” (Publication 523).
Lounise George, MBA, is a Tax Manager who has been with FF&F for over 11 years. She has over 16 years of accounting experience, and since joining FF&F has worked with a diverse group of clients. Lounise specializes in High Net Worth Individuals & Non-Profit Organizations.