Often, people sell a home and buy another, rolling profits from the sale of the first home into the down payment for the new house. But if you make enough of a profit on the sale of your house, you may have to pay capital gains tax. Read on to find out what you might have to pay.
Homeowners benefit from all kinds of tax exemptions, including a big one when it comes time to sell. The capital gains tax exemption allows a homeowner to make $250,000 from the sale of a house without paying any taxes on the income. Married couples are allowed a $500,000 exemption.
Requirements for the Capital Gains Tax Exemption:
You have owned and lived in the house as your primary residence for at least two of the last five years. This can be a good reason to wait a month or two to sell if you're just under the limit.
You haven’t taken the capital gains exemption on another house in the two years before the sale date. You're only allowed to take this exemption once.
If you and your spouse are taking the $500,000 exemption, at least one of you meets the ownership requirement, and both of you meet the use requirement. Recently married? Only one of you needs to have owned the house for at least two years, but both of you need to have claimed it as your primary residence for two of the last five years. If only one spouse meets the requirements, you can still take a $250,000 exemption.
For the $500,000 exemption, your tax status must be married and filing jointly. The majority of married couples do file joint taxes, but there are some cases when people choose "married, filing separately." If you're looking at a big profit on a home sale, it may be worth it to change your status for a year.
What You Won't Need to Claim the Capital Gains Exemption:
You don’t have to have claimed the house as your primary residence for two consecutive years in the last five, just two years total. Were you on sabbatical in Japan for a year? Did your company send you to Europe for 18 months? Lucky. As long as you claimed the house as your primary residence for at least two of the last five years, even if it was in six-month increments, you qualify.
You don’t have to meet the ownership and use requirements at the same time. This may apply to you if you rented a house, later purchased it from the owner, then rented it to a tenant.
You don’t have to be living in the home at the time of the sale, as long as you meet the use requirements. If you've already moved, but still lived there for two of the last five years, you can claim the exemption. If you're on the fence about selling, but you're about to miss that time limit, you might want to go for it.
Your spouse doesn’t have to be alive for you to exempt the full $500,000. What? They do have to have been alive within the last two years. It's not fun to think about, but you may want to sell your home after a spouse dies, though certainly not right away. If you're older, you're more likely to have built more than $250,000 worth of equity in your home. As long as you sell within two year's of your spouse's death, you can still take the full $500,000 exemption.
You may also be able to deduct the cost of any capital improvements you’ve made to your home over the years. Keep scrupulous records, even if you don’t plan to sell for years, because you'll need to document those costs for the IRS. So even if you do make more than $250,000 on the sale, you may still be exempt.
"Make sure you understand the ins and outs of this one. The capital gains tax exemption is one all homeowners should understand, because no one wants to pay more at tax time than they have to!"