One of the most frequently asked questions by taxpayers is: “Do I pay tax when I sell my home?” The short answer is, probably not – but it’s important to walk through the steps to determine if the sale of your home qualifies for the capital gain exclusion for the sale of a primary residence. This article will give a brief overview of the exclusion, and give you enough insight to determine if you’ll have to pay tax or not.
Step 1: Calculate Your Gain/Loss
The first step to determine whether or not the sale of your home is considered a taxable event is to calculate a gain or loss. To do this you’ll need to complete the following steps:
- Determine the original purchase price of your home.
- Add the cost of any major improvements (new roof, new driveway, kitchen renovation etc.) Regular repairs and maintenance don’t apply.
- Add any selling expenses incurred during the sale of your home (i.e. closing costs and brokers fees)
- Take the sum of 1, 2 and 3 and subtract it from the selling price of your home.
Loss: If the original cost plus major improvements plus selling expenses exceed the sales price then you have a loss on the sale of your home. No further action is needed and unfortunately you won’t be able to deduct the loss on your taxes.
Gain: If the sales price of your home exceeds the sum of 1, 2 and 3 then you have a gain. The next step is to determine if this gain is taxable or non taxable.
Step 2: See if you Qualify for an Exclusion
If you calculate a gain on the sale of your main residence then odds are you’ll be able to exclude most if not all of the capital gain. For single filers you’ll be able to exclude $250,000 in capital gains and for married taxpayers you’ll be able to exclude $500,000 in capital gains. To see if you qualify for the exclusion follow these steps:
- Automatic Disqualification: if you acquired your home through a 1031 exchange in the last 5 years or you are a non tax resident then you don’t qualify for the exclusion.
- Ownership Test: You owned the home 24 months out of the last 5 years leading up to the sale of your home.
- Residence Test: The home was your primary residence for 24 months out of the last 5 years leading up to the sale of your home. Doesn’t need to be 24 consecutive months, the home just needs to be used as a primary residence for 720 days during a 5 year period.
- Look Back Test: You can’t use the exclusion if you excluded capital gains on the sale of another home on any of your last 2 tax returns.
- Exceptions: If you recently got separated from your spouse due to divorce or death, your previous home was destroyed or condemned, or you sold a “remainder interest” than other rules apply (this is an entire article by itself).
If the automatic disqualifications don’t apply and you meet the ownership test, residence test, and look back test then odds are you’ll be eligible for the exclusion.
Step 3: Partial Exclusion
If for some reason you don’t qualify for a full exclusion then you may qualify for a partial exclusion. This is usually the case when homeowners fail to meet the residence test because they are forced to move due to work, health issues, or other unforeseen circumstances. The following are the eligibility requirements for a partial exclusion:
Work: If you or your spouse gets transferred or finds a new job 50 miles from your primary residence then you may qualify for a partial exclusion.
Health Related: If you have to move to take care of yourself, your spouse, or a family member then you may qualify for a partial exemption. This includes moving to care for a family member that does not live in your household (i.e. a parent).
Unforeseen Circumstances: This category is extremely broad and can include any of the following:
- Death of your spouse or other residents in the household
- Divorced or legally separated
- Gave birth to two or more children from the same pregnancy (oddly specific)
There are some other considerations that may impact whether or not the sale of your home will cause a taxable event. Here are some to look out for:
- Rental Use of the Home: If part of the home is used as rental property then that portion of the home is not eligible for the exclusion. You must calculate a separate gain or loss on the portion that is used as rental property.
- Business Use of the Home: If you claim the home office deduction then chances are you won’t be able to exclude a gain from the portion that is used for business purposes. This is the same concept as the rental use of the home. See the home office deduction trap for more details.
- You Can Use The Exclusion More Than Once: If you meet all the qualifications then you can exclude the gain from the sale of your primary residence multiple times in your lifetime.
This is a brief overview in determining whether or not you’ll have to pay tax on the sale of your home. Before you even think of selling your home you should discuss it with your CPA to determine if you’ll have to pay tax or not. Everyone’s tax situation is different so you want to make sure you get appropriate tax advice before making any major decisions.