From time to time, I get asked tax questions. A common question is: are there taxes on home sales? The best time to ask this question is not after you've sold your real estate, but if you've already passed the keys onto someone else here's what you need to know.
You Sold Your House. Now What?
Whether or not you are exempt from tax will depend on your filing status, the amount of the gain and your occupancy status for the property sold.
In the past there was a provision that you needed to reinvest your gain proceeds into a home that cost the same or more than the one you sold. But that rule went away in the 1990s and was replaced by a new rule. Under Internal Revenue Code Section 121, you only pay taxes when your gain on the sale of your primary residence is more than $250,000 above your basis if you are a single filer, or $500,000 if you are filing jointly. This rule doesn't apply to investment property sales or to the gain on that portion of a multi-family rental property that you did not live in as your primary residence.
Your gain is figured by determining your basis. Your basis consists of what you originally paid for the property plus certain closing costs at the time. Then you add in major home improvements (e. g. new kitchen, adding a room, etc.) and whatever real estate transaction fees you incurred.
To figure out the gain, take your sale price less this basis. If the difference is less than $250,000 (single filer) or $500,000 (filing jointly), you will have no tax on any of your gain. You will need to file a form with your taxes to document this. (For related reading, see: Avoid Capital Gains Tax on Your Home Sale.)
Taxes on Home Sales: Calculating Gain on Home Sale
Let's say you and your spouse bought your home back in 1993 at $157,000. At the time you probably had about $860 in closing costs that count toward your basis. Over the years you invested in certain improvements like a new room addition costing you $40,000. Your basis at this point is $197,860.
Now it's 2016 and you decide to sell. You get an offer that you accept for $553,500. At the closing you'll receive a check for proceeds net of your mortgage payoff, seller closing costs and real estate commission. Let's say you had a mortgage of $67,950, about $2,500 in closing costs (i.e. recording fees, attorney fees, courier charges) and another $33,200 for the real estate commission (about 6%).
At the closing you'll receive a check for $449,850.
You're feeling pretty flush, but then you think about taxes (unless you were proactive and reached out to your financial advisor before listing the property to model this ahead of time). How much of this $449,850 check do you now need to set aside for taxes? Your tax planner would tell you that you don't have to worry about taxes on home sales. Why? Your updated basis is the original purchase price plus the allowed closing costs when you bought and sold the property and the cost of that nice room addition. Finally, you add in the real estate commission as part of the selling expenses and it totals $233,560. (For related reading, see: A Tax Primer for Homeowners.)
Your gain is your sale price less the adjusted basis. So, in this case it is $319,940 ($553,500 less $233,560). As a married couple you have an exemption of $500,000 over your adjusted basis before any capital gains tax applies. Since $319,940 falls well within $500,000, you don't have any taxable gain.
Determining if Your Property Sale is Exempt
To best determine whether or not your property sale is exempt, you may want to speak with a qualified tax planner. You can also review the relevant IRS publication.
(For more from this author, see: 8 Ways You Can Minimize Taxes.)