When we moved into our current home, a house not very far from us had gone on the market a few times but had not sold. I learned from our real estate agent—and some chatty neighbors—that the house had been purchased when prices were relatively high, and it was considered challenging to unload because of some associated costs. A few months ago, it sold for $300,000 over the original asking price, making it nearly twice as expensive as most other homes in the area.
It was not an anomaly. Last year, one of my clients listed her home and confided in me that she wasn’t sure she could get the appraised value. It was in a lovely neighborhood, but she hadn’t been able to make renovations, and so it had the same 1960s-era fixtures as when she had moved in—in the 1990s. She later emailed me that she received a cash offer, as is, for nearly $250,000 over asking.
You probably have a similar story of your own. Housing prices have been soaring all over the country—much faster than wages. Fortune notes that home price growth (20.6%) is four times greater than income growth (4.8%) over the past year.
I’m not gonna use the b-word…but you know what I’m thinking.
Many homeowners hope to take advantage of rising prices before the market slows—or pops. As a result, my inbox has been full of your questions about the tax consequences of selling your home. Here’s a quick look at some of the most popular.
I know about the one-time capital gains exemption, but what happens when I sell another home during my lifetime?
There is no longer a one-time exemption—that was the old rule, but it changed in 1997. The Section 121 exclusion on capital gains up to $250,000 of the gain from your income, or $500,000 for married taxpayers, is available to all qualifying taxpayers who have owned and lived in their home for two of the five years before the sale. The years don’t have to be sequential; you can live in the house in year one and in year five and still qualify.
The capital gains exclusion applies to your principal residence, and while you may only have one of those at a time, you may have more than one during your lifetime. You can take advantage of the exemption multiple times as long as you meet the criteria.
What happens if I’m 55 or older?
Nothing. Your age doesn’t make a difference. There used to be a provision that allowed homeowners who are at least 55 years old to claim a one-time capital gains exclusion. Again, that’s no longer the case. The capital gains exclusion is available to all qualifying taxpayers who have owned and lived in their home for two of the five years before the sale, no matter how old you are.
During the pandemic, I bought a second home in North Carolina. If I sell my house in New York, do I qualify for the exclusion?
If you have more than one home, you can exclude the gain only from the sale of your main home. If you have two homes and live in both of them, your main home is typically the one you live in most of the time. You’ll want to count the days you were at each property. That said, facts and circumstances may also apply—where you’re registered to vote, where you pay your state and local taxes, and where you have your driver’s license may also help determine your main home.
Can I still claim the exclusion if my home is in a trust?
It depends. Generally, a revocable trust that meets certain criteria may be disregarded for federal income tax reasons. That means that the trust ownership would be ignored, and you would be treated as the owner. In that case, the exclusion would still apply.
However, a revocable trust that is not disregarded, or an irrevocable trust considered to be a separate entity for federal income tax purposes, will typically not qualify under Section 121. If that’s the case, then the exclusion would not apply.
I sold my house for $550,000. Does that mean I have to pay capital gains on the whole thing?
No. There are two concepts here that are very important: basis and capital gains exclusion.
Let’s talk basis first. Basis is, at its most simple, the cost that you pay for assets plus adjustments. When it comes to real property like your home, your basis is your cost plus any significant improvements. For example, if you buy a house for $150,000, that’s your cost basis. If you make a capital improvement—a major change that adds permanent value like an addition—it will increase your basis. Let’s assume that the addition costs you $40,000. Your basis is now $190,000, or $150,000 (original purchase price) plus $40,000 (addition).
When you sell your home, your gain is the difference between the selling price and your basis. So, continuing the example, if you sold your house for $550,000, and your basis was $190,000, your gain is $360,000, or $550,000 minus $190,000.
Now, let’s add in the capital gains exclusion. The exclusion is up to $250,000 for single taxpayers or $500,000 for married taxpayers. If you are married, you will subtract $500,000 from your gain (in this case, $360,000). Because the exclusion is more than your gain, you’d owe no capital gains tax on the sale. If you were single, you’d subtract $250,000 from your gain (again, $360,000)—because the gain is more than your exclusion, you’d owe capital gains tax on the gain of $110,000.
That amount is the gain, not the tax owed. If you owned your home for one year or less and then sold or otherwise disposed of it, your capital gain is short-term, and you’ll be taxed at your ordinary income tax rate. However, if you have owned your home for more than one year, your capital gain over and above the exclusion is long-term. For 2022, the long-term capital gains rates for most capital assets are 0%, 15%, or 20%, depending on your taxable income.
What if I lost money on the sale of my home?
Gosh, I hope you didn’t lose money in this market. But if you did, you can’t claim a capital loss on the sale of a personal residence—no matter how much it hurts.
When I sold my house, I had to pay off my mortgage and real estate taxes. Does that also reduce my gain?
No. When calculating your gain, you don’t consider your mortgage or real estate taxes as the seller. You’ll want to use the formula (selling price less basis), not cash in hand.
That said, if you paid interest when paying off the mortgage, you might be able to claim that as a home mortgage interest deduction on Schedule A if you itemize. The same applies to real estate taxes.
How will the IRS even know that I sold my house?
You’d be surprised at how many pieces of a real estate transaction can trigger some kind of tax form—from satisfying your mortgage to paying a third party at settlement. Most commonly, however, Form 1099-S is used to report the sale or exchange of real estate. When the IRS receives Form 1099-S, they match it to your tax return. If they don’t see the transaction noted, you may receive a notice, such as a CP2501, asking for more information.
I was thinking of doing a like-kind exchange for my house and…
I’m going to stop you right there. As part of tax reform, Section 1031 exchanges only apply to real property used for business or held as an investment. The so-called “like-kind” exchange or swap can be a great way to avoid immediate recognition of gain, but the provision does not apply to your home. And don’t think you can move out and then list your home simply to avoid the rule; an exchange of real property held primarily for sale does not qualify as a like-kind exchange.
Questions?
Selling a house in this market may seem like a breeze, but the tax consequences could complicate matters. Understanding what you need to know up front ensures much smoother sailing—and if you have questions, be sure to consult with a tax professional.
This is a regular column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl.