If you’re getting ready to put your house on the market, you may be asking yourself how your sale will affect your tax situation. This is a fairly common question since many homeowners want to know whether they’ll have to pay taxes when they sell their homes. Put simply, “It depends.” Read on for more information.
The amount of time you lived in your home before you sell it as well as how much profit you make will determine if you have to pay taxes. If you owned and lived in your home for 2 of the 5 years before the sale, up to $250,000 of its profit is tax-free. In the event you’re married and file taxes jointly, this tax-free amount increases to $500,000. This means you’ll only be on the hook for taxes if you make a significant profit on your home sale.
Your stocks, bonds, and home are all considered capital assets. When you sell a capital asset for more than you paid, you may have to pay a capital gains tax to the IRS. The good news is that homes are excluded from capital gains tax, as long as they meet certain criteria including:
As with any law, there are a few exceptions. If you had to move before owning your home for 2 years because of a job change or what the IRS considers an “unforeseen circumstance” like a divorce or natural disaster, you may be excluded from capital gains tax.
You can add the amount of money you spent on improving your home to the initial price of your home to get an adjusted cost and reduce tax capital gains. However, not all home improvements are eligible. You can add the amount of money you spent on things like a roof replacement, deck addition, or basement finish. Unfortunately, ordinary repairs and maintenance don’t count.
To calculate your capital gains, do the following:
Let’s say you bought your home for $200,000 6 years ago. You paid $10,000 in taxes and closing costs and also made $40,000 in home improvements. Your “cost basis” amount would be $250,000. You sell your home for $400,000.
To calculate your capital gains, you’d subtract $250,000 from $400,000. Your capital gains would be $150,000. Since you bought your home more than 2 years ago, the $150,000 is yours tax-free.
So, how much will Uncle Sam take if you have to pay capital gains tax? The new federal tax law considers your income, rather than your tax bracket. Here are the details:
It’s important to note that your state may have its own tax laws on income from capital gains, so it’s a good idea to become familiar with these in addition to the regulations from the IRS.
If you do have to pay taxes on your home sale, it won’t be taken out of your transaction immediately like your paycheck withholdings. Instead, you’ll be required to report your profits in the “income” area of your tax return. Make sure to set aside extra money so you can pay the IRS once tax season rolls around.
Have further questions about whether you have to pay taxes for your home sale? Contact us today!
