How can I avoid paying capital gains tax on sale of our primary home?
We mortgaged our home in Colorado to purchase a home in Florida this year. The Florida home is now being used as a rental to offset our costs. When we sell our Colorado home and move to Florida, that home will become our primary residence. How can I avoid paying or reduce payment of capital gains tax to Colorado and the federal government?
You should always consult a tax professional who is familiar with your personal circumstances. However, unless you have something different with your circumstances not listed here, it appears you can eliminate or at least lower your capital gains tax depending on the amount of the gain. Having a mortgage does not affect this.
The IRS offers a capital gain exclusion upon the sale of your primary residence up to $250,000 if you are single and $500,000 if you are married. You are eligible for this exclusion if you have owned and used the home as your primary residence for two out of the last five years. You can view more information here https://www.irs.gov/taxtopics/tc701.html
The $250,000 exclusion is per person, if the property has been your primary residence for at least 2 of the last 5 years, is often the biggest help in reducing the capital gains tax owed by a home seller. But in addition, you can make some good dents in your tax bill by making sure that you have fully calculated your cost basis in the property.
Your starting point in calculating your basis is the full original purchase price you paid, regardless of whether or not you took out a mortgage to make the purchase. To this amount, you can add the expenses you paid to make the purchase (e.g. attorney fees, the cost of title insurance, and any settlement fees).
Now comes the part that might take some digging through your receipts as well as your memory. To your purchase price, you can add the cost of any additions and improvements that had a useful life of over 1 year, made while you owned the property. A few examples of what could be included are built-in appliances and cabinets, flooring, storm windows, a new roof, a security system, landscaping, insulation, pipe and duct work, central air conditioning, a water heater. The list is quite long -- I’ve included a varied mix to give you some ideas.
And then finally, you will have your selling costs to add to your basis number. This will include the fee paid to the real estate broker and your attorney, as well as any transfer taxes that you will be required to pay.
It would probably be helpful to have a consult with a tax expert or a financial advisor to make sure that you have accounted for everything that can be claimed. Once you start adding them up, all the amounts that you put into your home over the years can give a good boost to your cost basis. Subtracting this fully-loaded basis from your sales price, and then taking your $250,000 per person exclusion, should get your capital-gains tax bill to its minimum, and may even eliminate it completely.
Current tax rules provide you with the ability to avoid capital gains taxation on the first $250,000 in gains on your primary residence ($500,000 for a married couple). For the purposes of the tax rules, a "primary residence" under this tax exemption is any home that you used as your principal residence for any 2 of the last 5 years.
It sounds like you are currently residing in the Colorado home. As long as you have resided there for at least 2 of the last 5 years as of the time of the sale, that home should qualify for the exemption. The fact that you recently took out a mortgage has no impact on the capital gains discussion; although, you may receive a deduction for the interest you are paying.
It goes without saying that you should consult your tax professional to confirm all of the above.