Selling my home - do I owe Capital Gains Tax ?
Upon selling my home, do I owe any Capital Gains Tax?
You may be in a situation where you may owe none at all…this because (1) if there is a loss on the sale, then there is no Capital Gains that are applicable. Also know that “losses” are not deductible relative to the sale of your home.
On the other hand (2) if there is a profit on the sale, then you may be subject to owing a Capital Gains tax.
So before you panic, you the home seller needs to understand the rule in regards to a potential Exclusion of Capital Gains Taxes. There is some “details” the home seller needs to know and I will explain them as we-continue-on with this article OK?
How and how much of my profit can I exclude from Capital Gains?
For starters, your home sold and/or to be sold must be your “principle” place of residence. In addition the home-seller must have lived in the home for a minimum of two out of the last 5-years prior to the date of the sale/closing. This is known as the Internal Revenue Service (IRS) ownership eligibility requirement test and at times it is referred to as the “use test”.
For a married couple filing jointly, only one spouse has to meet the ownership requirement.
If a homeowner/seller meets the 2-out-of-5-year “principle residence” and use test, then an unmarried individual can exclude up to a maximum of $250,000 in profit from the sale of the home. And a married couple can exclude $500,000 maximum of profit. These "exemptions” came to life via the Taxpayer Relief Act of 1997.
And guess what folks... you can claim the exclusion once every 2-years as long as the house that is sold is your principle residence and you meet the eligibility requirements.
The benefit of the $250,000 (unmarried) and $500,000 (married) maximum Capital Gains Tax Exclusion is not applicable to rental properties nor any commercial properties that you may own.
Examples of this Exclusion are: (remember, must meet the 2-out-of-5-year test to be eligible)
Let’s say you're single (unmarried) and you realize a $230,000 profit on the sale, you don't have to report any of it as taxable income because this is less than the $250,000 exclusion amount you're entitled to. But if you realize a $273,000 profit or gain, then you must report $23,000 of Capital gains taxable income.
If married and your realized profit is under $500,000 then no taxable gain is to be reported. If your profit is over $500,000 then the amount above and beyond the $500,000 must be reported as Capital Gains taxable income.
How and where is Capital Gains reported?
Though your home is considered personal property – for tax purposes it is a Capital asset.
So therefore you need to know that if you owned your home for 1-year or less and if it is sold, the gain realized is reported as a short-term capital gain. (Schedule D form 1040). Short-term gains are taxed at the same rate as regular income. (“Short-term” capital gains are less favorable than “Long term” capital gains when it comes to taxation)
If you owned your home for more than one year and if sold, any realized Gain is reported as a long-term capital gain. But remember that if you are eligible for the awesome tax exclusion of $250,000 or $500,000 that is mentioned above, then any Gain on the sale of your home that is above and beyond your eligible exclusion amount, is also reported on Schedule D (form 1040).
Is there any exception to the two of 5-year ownership test/rule?
Yes… after the purchase of the home, if an “unforeseen circumstance” has afflicted the homeowner in such a way that the house needs to be sold, then the homeowner may qualify for a “Partial Exclusion” of the gain on the sale.
The word “may” is key because if you don't meet the Eligibility Test, you may still qualify for the benefit of a partial exclusion of any gain. You can meet the requirements for a partial exclusion if the main reason for your home sale was a (1) change in workplace location, (2) health issue, or (3) an unforeseeable event.
(1) Change in workplace location – If you accepted a new job or transferred, the new work location must be at least 50 miles farther from the old work location or from your home if no previous work location (ie: unemployed)
(2) Health Issues – for example: A doctor recommended a change in residence for you because you were experiencing a health problem. This could range from the quality of the air in the current area the home is located, to the homeowner needing to be closer to medical facilities and/or doctor in order to be better provided relative to facilitating any diagnosis, cures or treatment of disease, illness, or injury for yourself or a family member.
(3) Unforeseeable Events – These are situations where a homeowner could not have reasonably known the future of what was to come about nor could they have anticipated the unforeseeable circumstance at the time when the home was purchased. They are but not limited to a financial hardship due the death of spouse, divorced, legally separated, loss of job or a natural disaster has rendered your home uninhabitable.
How can I take a Partial Exclusion?
Remember that the ownership eligibility requirement test is based on a 24-month period (2-out-of-5-year ownership).
You can calculate your partial exclusion based on the amount of time you actually lived in your home. Count occupancy months, then divide the months/number by 24. Multiply this ratio by $250,000 (unmarried) or by $500,000 if you're married. The result is the amount of Capital Tax Gain you can exclude from your taxable income.
Military personnel have a slightly different treatment in regards to the ownership eligibility period to qualify for the Capital Gains Tax exclusion.
When you are on qualified official Military extended duty, the treatment of eligibility difference is that it falls in the category known as ”Suspension of Time”. Meaning that, because of your service, you may choose to suspend the 5-year test “use” period in regards to ownership.
You may “suspend” the time (ie: extend, push forward) of the 2-out-of 5-year rule. The suspension may last no more than ten years, for a total “lookback” period of 15 years.
The “Military Service” methodology in regards to Capital Gains Tax Exclusion varies when it comes to calculating the 2-out-of 5-year rule. Therefore, the simplest way to look at this “suspension of time” is that, under normal circumstances, military families can exempt profits from capital gains if they lived in a house for two of the previous 15-years before the sale. That is if your PCS orders takes you at least 50-miles of your home.
Note: There is an important item a home seller needs to consider when it comes to the sale of your home... and that is figuring out the "Cost Basis" of your home. The Cost Basis is subtracted from the selling price. Your realized Capital Gain if any would be the sales price of your home less your cost basis. If it is a negative number, then you have incurred a Loss.
Hope you have gained a little bit more of knowledge in regards to a tax exclusion that you the homeowner may possibly be eligible for upon the sale of your home. I want to make it known that I am not a Tax Attorney, a Tax Accountant nor a Certified Tax Accountant (CPA). My intent and the purpose of this article is to supply you with some information in regards to the “Capital Gains Tax Exclusion”, increase your understanding of it and for the homeowner to seek help on more detailed tax information and calculation especially for those in the Military. How the above information applies to you the homeowner?... I recommend you make it a point to contact your Tax Accountant, CPA and/or Tax Attorney.
When you are ready to sell, my hope is that you contact me to “List your home for sale”. It would be my pleasure to work for you.
Oscar Castillo : BROKER - REALTOR® (San Diego, CA)
(858) 775-1057
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