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June 29, 2022

Taxes on Selling a House: Capital Gains Tax, Exclusion, and More!

Personal Taxes

So you’ve looked at rising real estate values and made the decision to sell your home.  Great!

But what about taxes?  Isn’t there some kind of home sale exclusion you get when selling your home?  What if you rented out your home for some time and then moved back in?

Capital Gains on Selling Your Home

Your home — like most assets you own for personal or investment purposes — is a capital asset.

Internal Revenue Code Section §1221 defines a capital asset as any property you hold except for eight things:

  1. Stock in trade (basically, inventory)
  2. Real property used in a business or subject to depreciation
  3. Most intellectual property such as patents and artistic compositions for which the taxpayer’s personal efforts were expended in creating the property
  4. Accounts receivable in the ordinary course of business
  5. Certain publications of the United States Government
  6. Certain derivative financial instruments
  7. Certain hedging transactions
  8. Supplies used in the ordinary course of business.

Anything not included in that list is a capital asset.

So because primary residences are not included in that list, your primary residence — the home that you live in — is in fact a capital asset, and you will realize capital gains on the sale of your home unless, of course, you’re selling it for a loss or it qualifies for an exclusion.

The amount of your capital gain is the difference between your net proceeds — and that includes the mortgage payoff, if there is one — and your basis in the home.

And basis of your home does include not include the original “purchase price” but also things like title fees, legal fees to prepare the contract, escrow fees, recording fees in the county office, appraisal costs, and other costs you incurred to purchase the property.

Your basis also includes certain capital improvements you’ve made to the property over the years, such as if you added an additional bedroom.

So if you bought your home for $200,000, you paid $5,000 in closing costs on the sale, and you made $45,000 in improvements to the home over the years, your basis in the home would be $250,000.

Now let’s say you sell the home for $500,000 but after selling expenses like real estate broker commissions and other selling and closing costs, you net $450,000 on the sale, $100,000 of which goes to paying off the mortgage on the home.

Your capital gain on this transaction is $200,000, which is your $450,000 net proceeds on the sale less your $250,000 basis.

How much tax you pay on this sale depends on, first, on how much, if any, of this gain you can exclude under the home sale gain exclusion and, second, your capital gains tax rates for the year.

The Home Sale Gain Exclusion

Section 121 of the Internal Revenue Code offers taxpayers who sell their principal residence an exclusion of up to $250,000 of realized gain on the sale of a home for single individuals ($500,000 for married individuals who file jointly).

In order to qualify, taxpayers must have both owned and used the property as their principal residence for at least two of the last five years ending on the date the property sells.

These two years do not have to be consecutive; a taxpayer will still qualify for the exclusion if they lived in the property for a year, moved somewhere else for three years, and then moved back to the property for a year.

Also, in the case of joint returns, while both spouses have to meet the use requirement — they must both have lived in the property for at least two of the last five years — only one spouse is required to have met the ownership requirement.

It’s not uncommon for properties acquired before marriage to be titled only in the name of the spouse who purchased the property before marriage; it is not necessary to retitle the property in the names of both spouses in order to qualify for the home sale gain exclusion (though there may be other reasons why retitling the property would be advantageous).

Important: There are other things to know about the home sale gain exclusion such as partial exclusions, calculating the exclusion if you used the home for rental use, calculating the exclusion if you took the home office deduction on a part of the home, combining a 1031 exchange with the home sale gain exclusion, and more.  Read this article to learn more about the ins and outs of the home sale gain exclusion.

Capital Gains Tax Rates

Now, what if your property does not qualify for the home sale gain exclusion?

Or — lucky dog, you — your gain is greater than the $250,000 or $500,000 exclusion amount for your filing status?

In these cases, you are looking at paying capital gains taxes.

If you’ve owned your home for a year or less, you will be paying taxes on the taxable gain in your home at the short-term capital gains rates, which are equal to your ordinary income tax rates.  Basically, you will pay taxes at the same rate on the sale of your home as you do on your W-2 wages.

Thankfully, if you’ve owned the home longer than a year — at least a year and a day — you will pay taxes at the long-term capital gains rates, which are lower than your ordinary income tax rates.

Tax Filing Status0% Rate15% Rate20% Rate
Single$0 - $41,675$41,676 - $459,750$459,751+
Married Filing Jointly$0 - $83,350$83,351 - $517,200$517,201+
Married Filing Separately$0 - $41,675$41,676 - $258,600$258,601+
Head of Household$0 - $55,800$55,801 - $488,500$488,501+

Note that these capital gains rates are based on your taxable income including the non-excluded gain on the sale of your home.  This means that your standard deduction or itemized deductions is / are deducted when calculating this amount.

Taxes on Selling an Inherited House

If you inherited a property, your basis in that property is equal to the value of the property on the date of death of the decedent — the individual who left the property to you.

This is obviously a very good scenario from a tax perspective.  Let’s say Grandpa and Grandma bought the house they left you in 1960 for $10,000.  Grandpa died some time ago, leaving Grandma the sole owner of the house.  Then let’s say Grandma died in 2022, when the house was worth $1,000,000.

Your basis in the home, therefore, is its $1,000,000 fair market value on the date Grandma passed away; the $990,000 appreciation in the house from the day Grandpa and Grandma bought the house in 1960 and the day Grandma died in 2022 is never taxed.

Of course, any appreciation in the house from the day Grandma died and the day you sell it is taxed like any other gain — unless, of course, you live in the house for two out of the last five years and use the home sale gain exclusion!

But let’s say you sell it shortly after Grandma’s death for $1,100,000, netting $1,000,000 after selling costs.  In this case, you would have absolutely no taxable gain on the house because your net proceeds are equal to your basis.

In order to establish the value at the date of the decedent’s death, you will need to obtain a date-of-death appraisal.  Generally, there are appraisal companies that specialize in doing such appraisals.

Taxes on Selling an Gifted House

If you were given a house, then as a general rule, the gifter’s basis in the home is carried over to you, the recipient of the gift.

This is generally much less advantageous from a tax perspective than inheriting a house.

There are exceptions to that general rule depending on whether the donor’s basis was more or less than the fair market value of the home and whether they gift tax or not, but that’s the general rule.

But in general, if Grandpa and Grandma purchased their house for $10,000 in 1960, make $40,000 of capitalizable improvements over the years to it, and gift it to you in 2022 when it’s worth $1,000,000, your basis is a mere $40,000.

If you turn around and sell it, say, for $1,100,000, netting $1,000,000 after selling expenses, you will have to pay tax on gain of $960,000 on the sale — unless, of course, you are able to exclude $250,000 / $500,000 of it due to the home sale gain exclusion.

Taxes on Selling a House If You’re in the Military

Generally, to qualify for the home sale exclusion under Section 121, you must have both owned and lived in the home as your primary residence for at least two of the last five years.

However, if you or your spouse are on active military duty at a duty station that’s at least 50 miles away from your primary residence or you are living in government housing as a condition of your military service, you can choose to suspend the five-year period required for the home sale gain exclusion by up to 10 years.

So let’s say you lived in your home from January 1, 2006, to January 1, 2009 — a period of three years.  But then let’s say you were on active military duty at least 50 miles from your home for the next 10 years until January 1, 2019.  You then sell the home a year later on January 1, 2020.

In this case, you can choose to ignore that entire ten-year period from January 1, 2009, until January 1, 2019, for purposes of the home sale gain exclusion, and you would qualify for the home sale gain exclusion based on the fact that you lived in the home for at least two years of the five-year period including January 1, 2005, to January 1, 2009, and January 1, 2019, to January 1, 2020.

Form 1099-S

In January of the year after you sell your home, you may receive a Form 1099-S from the escrow company you used on the sale of your home.

This form will indicate the gross proceeds on the sale of your home to you.  This amount includes not only cash you received in the transaction but also the principal amount of any loan that was paid off on the sale.

However, these gross proceeds are not reduced for costs of the sale such as sales commissions, deed preparation costs, advertising expenses, or legal fees.

If you receive a Form 1099-S, you must report the sale of your home on your tax return even if the entire gain is not taxable due to the home sale exclusion.

Author:

Logan Allec, CPA

Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.

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