When you start thinking of selling your home, you may wonder whether capital gains taxes will eat a portion of your profits. Explore the topic of capital gains and exemptions to find out what you can expect when you sell your home.
What are Capital Gains Taxes?
A capital gains tax is levied on profits (aka capital gains) that result from the sale of an investment. While you may be used to hearing the phrase “capital gains tax” in relation to real estate, you may also be taxed for the sale of a stock.
To calculate the amount of capital gains you will be taxed on, subtract the purchase price of your home from the selling price. For instance, if you sold your home for $400,000 and paid $150,000 for the home, you’ll be taxed on $250,000.
If you are subject to capital gains tax, you will receive a 1099-S form, which is generated by the real estate agent, and you’ll report the capital gains on your taxes. If you think your home sale is exempt from capital gains, discuss it with the real estate agent before you start showing it to buyers.
Who Pays Capital Gains Tax?
Since the rules changed in 1997, many homeowners can avoid a capital gains tax and keep all the profits from selling their home. However, there are exceptions to note. You may be taxed if:
- The home was not your primary residence – If you have a full-time residence and a weekend beach home, you would be taxed when selling the beach home since it is not your primary residence.
- You did not own the home for two years – To realize a tax-free home sale, you must have owned your home for at least two years during a 5-year lookback period.
- You lived in the home – If you rented out the home for more than three of the five years before the sale, you may have to pay capital gains taxes. To avoid capital gains you must prove that you lived in the home for two of the five years prior to the sale.
- You claimed an exemption previously – If you claimed exemption from capital gains taxes within the last two years, you cannot qualify again. Wait until it’s been more than 24 months to sell a second primary residence and avoid capital gains.
- You earned over $250,000 single/$500,000 married – Single individuals must pay capital gains tax on profits over $250,000 and married couples must pay taxes on profits over $500,000. For instance, if you are single and you profited $300,000 on the sale of your home, $50,000 of your profit is taxable.
Exceptions to the Rules
There are exceptions for couples who spouse passed away, divorcing couples, and members of the military, foreign service or intelligence service.
Active duty service members can suspend the five-year testing period for as long as 10 years any time they choose. This may be a good idea if you own a home but anticipate serving overseas for several years.
If you lost a spouse and you want to sell your home, you can count the period of time that your deceased partner lived in the home toward your qualifying period of residence, so long as you are not remarried at the time of the sale.
If you and your spouse are divorcing and you have sole possession of the house, you can count the time your spouse lived there toward your two years’ residence requirement.
If you aren’t sure whether to take the capital gains exemption, you may wish to talk to a tax lawyer. They can review your particular situation and advise you on the best way to handle things.