Your home is probably one of the most significant purchases you’ll ever make in your life. It’s also one that comes with a lot of pride and emotion. Now, it’s time to sell. Of course, you want to make a profit, but what about the tax implications? Here’s what you should know if you’re selling your home this year.
In most circumstances, gains from capital asset sales (such as property) are taxable. But, thanks to the Taxpayer Relief Act of 1997, most home-sale profit is tax-free—if you qualify for the Section 121 Exclusion. This Internal Revenue Service rule allows you to exclude a gain of up to $250,000 from the sale of your primary residence, or up to $500,000 if you file a joint tax return with your spouse.
Do you qualify for the primary residence tax exclusion?
To qualify for the Section 121 Exclusion, you must meet both the ownership test and the use test: you must own and use the home as your main residence for a period adding up to two years out of the five years before it is sold. There are some exceptions, however. For example, if you or your spouse are on qualified official extended duty (for more than 90 days) in the Foreign Service, Uniformed Services, or the intelligence community, you may elect to suspend the five-year test period for up to 10 years.
Exclusion limitations
Generally, you’re not eligible for the exclusion if you:
- Excluded the gain from the sale of another home during the two-year period before the sale of your home
- Are selling a secondary residence, such as a vacation home
- Frequently buy and sell primary homes (Generally, you may exclude the gain from selling your primary home only once every two years, although some exceptions may apply)
- Are selling a rental property
- Are selling property used in a trade or business
What if my home sells at a loss?
You can’t deduct the loss on your tax return if you sell your main home at a loss.
You can refer to Publication 523 for the complete eligibility requirements, limitations on the exclusion amount, and exceptions to the two-year rule.
How to report the sale
If the gain is not taxable, you may not need to report the sale to the IRS when you file your taxes. However, you must report the sale on your tax return if you can’t exclude all or part of the gain, or if you choose not to claim the exclusion. Even if the gain from your home sale is excludable, you’ll need to report it if you receive an informational income-reporting document. The IRS requires those who get Form 1099-S, Proceeds from Real Estate Transactions to report the gain from a sale on their return, even if it is excludable under Section 121. You must also report the sale of the home if you can’t exclude all of your capital gain from income. When required to report a home sale, use Schedule D (part of Form 1040), Capital Gains and Losses and Form 8949, Sales and Other Dispositions of Capital Assets.
After you sell your home and move, remember to update your address with the IRS using Form 8822, Change of Address.
What about installment sales?
An installment sale is a sale of property under a contract that allows for all or part of the selling price to be paid in a later tax year. If you have an installment sale, you’ll need to report the sale under the installment method unless you have elected out on or before the due date for filing your tax return (including extensions) for the year of the sale. Even if you use installments to defer some of the gain, you can still use the exclusion of gain under Section 121.
How to reduce tax when selling a home
Even though median home sales prices have more than doubled over the past two decades, the $250,000 or $500,000 profit thresholds haven’t changed since 1997, which means that many long-term homeowners may be at a disadvantage with regard to Section 121. If you exceed the exemptions and owe taxes, you may reduce profits by adding certain home improvements to the original purchase price, known as basis. Additions such as patios, landscaping, swimming pools, new systems, and more may qualify as improvements. However, you will need to show proof of improvements using receipts and property tax history. You may also increase your home’s basis by adding certain closing costs, such as title, legal, or surveying fees, along with title insurance.
Selling your home this year?
Consider working with a financial advisor to ensure you’re getting all the tax credits, exemptions, and deductions you’re entitled to. Schedule a consultation with our team today.