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Tax Implications If You Sold Your Home or Are Thinking of Selling This Year?

by
Steward Financial
on
11/26/2017
Tax Implications If You Sold Your Home or Are Thinking of Selling This Year?

There's an old saying about real estate: Location, Location, Location. But as essential a factor as the location may be to the success of a sale, there are also financial and tax considerations that must be taken into account. Whether you are a homeowner considering selling your house or you've already made the sale, there are things you need to know and prepare for in order to keep yourself from facing unexpected penalties, fees, and expenses. These considerations include the home-sale gain exclusion and what situations it applies to, whether any portion of a home is used as a daycare or home office, whether the property or any part of it was used for rental income, the “2 years out of 5” rule, and whether the purchase/sale was a tax-deferred exchange.

Home Sale Gain Exclusion

When a homeowner sells their home and the sale reflects a profit, the Internal Revenue Service allows them as a single person up to $250,000 as long as they lived there and owned it for a minimum of 2 out of the 5 years up to the sale, unless they've used the exclusion for another property in the two years immediately before the sale. For married homeowners that allowance doubles to $500,000. With the exception of instances of those concurrent sales, taxpayers are allowed to take advantage of the exclusion an unlimited number of times for primary residences: it is not available for properties used for rental income or for second homes, and in some cases, the amount of the exclusion may be lower.

2 out of 5 Rule

The “2 out of 5 years” rule may seem self-explanatory, but it bears further explanation because there are some exceptions, as well as some nuances about which questions sometimes arise. At its most straightforward, a couple needs only to have owned and used the home for two out of the five years immediately preceding the sale to qualify for the $500,000 gain exclusion, and for a single person the exclusion is half that, $250,000. However, not every couple lives together or owns a home together. What then? To get the $500,000 exclusion, both spouses must use the home for the two years, but only one's name has to be on the title. Going away to allow the property to be rented, or to go on vacation or other short trips doesn't negate the use of the home, and if one member of the couple is not actually using the home for two out of five years it does not eliminate the exclusion – it just cuts it to the single level. For those who have acquired their home in a 1031, or tax-deferred exchange, the rules tighten up a bit by requiring at least five years of ownership before qualifying for the exclusion.

The tax code allows for challenging circumstances that can cause a homeowner to sell earlier than the full 5-year-period: these include health crises and job-related moves, both of which may qualify for a pro-rated exclusion amount. There are also exceptions for military members and government employees whose deployment or relocation may have forced a shorter duration of ownership. To see whether your circumstances warrant a pro-rated or reduced exclusion, contact our office.

Business Use of the Home

More and more people are using their home as their place of business or as a place to store their business' inventory, and in doing so claim a tax deduction. If prior to selling your home you claimed a depreciation related to a business use, you are not able to exclude the amount that you claimed.

Figuring Gain or Loss from a Sale

So, if you have sold your house and want to figure out whether you gained (or lost) money, it is not as simple as just subtracting the purchase price from the sale price (or vice versa). You do start with the purchase price, but to that number, you need to add any monies spent on improvements and upgrades. From this figure you want to determine your tax basis, which is calculated by taking the figure you've just arrived at and subtracting any depreciation that you've claimed and any casualty losses that you've claimed. With this number in hand, you are almost there. Now you just need the amount that you sold the home for, then take away all of the expenses incurred in selling the house and the tax basis and you'll have arrived at exactly what you gained (if you've ended up with a positive number) or lost (if you've ended up with a negative number). From that point, you work with the exclusion. Though there are no write-offs available for a loss on the sale of personal-use property, if you've had a gain then this is where you calculate how the home-gain property exclusion affects you. Assuming that you qualify, subtract the amount that you gained from the home-gain exclusion ($500,000 for a married couple and $250,000 for a single). If you end up with a positive number, you can exclude the gain. Any negative number is a taxable gain. Not only will you have to pay income taxes on this figure, but you may also be subject to a tax on net investment income.

The taxes that you are subject to on a home gain depend upon a few different variables, including your income and how long you've owned the home. For those whose ownership exceeded 366 days (a year and a day), any gain beyond the exclusion is considered a long-term capital gain and taxed at the special capital-gains rate. If you are a high-income taxpayer, that rate is 20%, and the Affordable Care Act also introduced a 3.8% net investment income surtax that may apply. The special capital-gains rate can drop to nothing for low-income taxpayers. The rules are complex, so professional help is advised.

One note of caution: if you have owned your home since before May 7, 1997, and the purchase was made after you sold another home, the calculation of its tax basis may be different, as before that day the gain on a home's sale was treated differently. At that time the gain from the previous sale would have been deferred to the new home purchase, thus reducing its tax basis today. That means that your gain would be even higher. 

Using Your Home as Rental Property

Starting in 2009, a law was introduced to force property owners to account for rental appreciation, keeping landlords from excluding gains on their rental properties by moving into their rentals for 2-year periods, which was happening frequently. This provision applies to all rental periods since the beginning of 2009. 

Records

Though it may seem hard to believe, there are many people who try to rely upon their memory to calculate gains and losses, or to assure the government of the veracity of their calculations. Documentation is essential, as home gains and losses often amount to hundreds of thousands of dollars. Make sure that you keep all of your paperwork, from the escrow statement at the time of your purchase and sale to any home improvements that you make over the years. This documentation will be essential for assuring that you are taxed appropriately.

Selling your home is far more complicated today than putting up a for sale sign. When you're ready to sell, make sure that you include a call to your tax professional on your to-do list.

Jon Osborn, EA writes for TaxBuzz, a tax news and advice website. Reach his office at [email protected].

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Steward Financial

Steward Financial

Jon Osborn is a tax preparer based in San Dimas, California. His company, Steward Financial Services, offers a broad range of tax preparation, accounting and business consulting for small businesses. He loves to work with clients who are looking for answers to complex tax and business planning issues. He has owned several small businesses and worked with over one hundred small business owners. He helps his individual and business tax clients find the best ways to spend their money in order to minimize IRS tax. Small businesses looking to grow, sell or just increase cash flow are one of Jon's specialties.

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