Selling your home can be a long and tedious process. After piles of paperwork and negotiations, it’s important to remember that your work won’t be finished until tax season ends. Depending on certain qualifications, you may need to pay a tax on the profit of your recently sold home. But, you may be off the hook. Here’s how to know if you will need to pay taxes on your capital gains from your sale.
How Do I Qualify For An Exclusion?
First things first, it’s essential to understand the circumstances under which you would or wouldn't have to pay a tax on your profit. The particular tax is called the capital gains tax, but you may be eligible for an exclusion if you meet these requirements:
- Your capital gain is less than $250,000 (or $500,000 if you are a married couple filing taxes together)
- You owned the home for at least two years
- The home was your primary residence for at least two years
- During that two year period, you did not exclude capital gain tax on the sale of another property
With these conditions, most people won’t need to pay a tax on their capital gain.
How Do I Calculate My Capital Gains?
It seems fairly simple, but to be sure if you qualify for a tax exclusion, you need to figure out the exact amount of your capital gain (hint: it’s a little different than the profit).
To find out the amount of your capital gains, you need to take into account the original price of the house plus any money you put into remodeling or improving your home, also known as the adjusted basis. Take the adjusted basis and subtract it from the amount you sold your home for (making sure to deduct selling costs). If that amount is less than $250,000, or $500,000 for married couples filing together, then you are eligible for a capital gains tax exclusion and you won’t need to pay any tax on your gain from selling your home.
For example, you bought your home five years ago and paid $200,000 for it. You then spent $25,000 remodeling the home, making your adjusted basis $225,000. You’ve just sold it for $300,000, with $5,000 of the price going toward selling costs (agent commission, legal fees, advertising, etc.). After taking out the selling costs, that number comes to $295,000. Then, subtract the adjusted basis of $225,000 from $295,000, making your capital gain $70,000.
Because your gain is less than $250,000, you owned and lived in the home for over two years, and did not receive a capital gain exclusion on selling another property during that time, you are eligible for a capital gains tax exclusion.
Let’s say your capital gain is more than $250,000. Up to $250,000, or $500,000 for married couples, of your gain will not be taxed, but the rest will be. The amount taxed on your capital gain is similar to income tax.
There are a few other circumstances under which you will not be eligible to get the tax exclusion even if you meet the main requirements. If you purchased the home through a 1031 exchange or are subject to an expatriate tax (emigration tax), you cannot receive an exclusion on your capital gains tax.
If you are moving to a nursing home, were advised to move by a doctor for health reasons, are moving because of a change in your employment, are selling your home during a divorce, or are selling because of an unexpected life event, like a birth or death, you may still be able to get a capital gains tax exclusion even if you do not meet the four primary qualifications.
Whether or not you will have to pay taxes on your capital gain or not, there are some things you need to do to prepare for tax season. First, make sure to save all of your receipts from home improvements in order to correctly calculate your capital gain. Also, make sure to meet with professionals who can advise you thoroughly on all of the tax implications of selling your home.
If you are interested in selling your home, the best way to start is by connecting with a local and experienced real estate broker to guide you through the process. Clever Partner Agents are professional, seasoned and talented brokers who can help you sell your home for one single fee.