Tax Consequences

Prior to Congress passing the Taxpayer Relief At of 1997, homeowners only had two options when profiting from the sale of their home: pay significant capital gains on the property or purchase a house of greater value within two years.  Only homeowners above the age of 55 were eligible to exclude a certain amount of profit and even then, were only able to do so one time.

Today virtually all sellers with the exception of those at the highest end of the market can keep all the profit they receive from the sale of their house with negligible tax consequences.   This makes homeownership a potentially lucrative mean long-term.

Capital Gain

For the majority of sellers, capital gain is the discrepancy between what you paid for the house and what you sold it for with the capital improvements not included.  Capital improvements are those that change the structure or livability of the home and includes remodels and room additions.

Todays tax laws allow for the following:

1.  Married couples and co-owner who file taxes jointly can keep up to $500,000 in profits tax-free if the sale is of a home they have owned and lived in for at least 2 of the past 5 years.  Anything exceeding this amount is taxed 20%.

2.  Single homeowners are eligible to keep up to $250,000 in profits tax-free is the sale is on a home they have owned and lived in for at least 2 of the past 5 years.  Anything exceeding this amount is taxed at 20%.

3.  Rental property owners are allowed to defer some capital gains tax if they purchase an additional rental property as well as qualify for 1031 exchange but are excluded if they buy a personal residence.

Todays tax law mean that you can sell a house every 2 years and avoid paying taxes on the profits.  If you own and occupy the house for less than two years prior to selling, you can qualify for a prorated exclusion from the capital gains tax but only if you are selling due to a job transfer or health issues.  These laws and rules are constantly being altered by the IRS and Congress so be sure to confer with your tax advisor.

Calculating Improvements

Many home improvements do not constitute capital improvements.  For example, replacing the roof is certainly an improvement but does not add value to the home and therefore is not a capital improvement.  Remodeling a bedroom or adding on a bathroom does increase value and does count as a capital improvement.  Start a file from the moment you purchase a home so that you can keep track of all you invest into the property.  Include the closing papers and appraisal records in the file.  Save all documents dealing with improvements and separate them based on whether they are capital improvements or regular maintenance and repairs.  Even if you do not expect to pay capital gains taxes, it is important to document these improvements to validate the asking price when you sell.

Selling for Less

If you have to settle and sell your home for less than you paid for it you cannot claim a capital loss.  Additionally, you may be required to pay income taxes if your lender agrees to forgive a remaining mortgage debt.  This law is being addressed by Congress so discuss the situation with your tax advisor.

Home Offices

If you work from home you may be susceptible for tax consequences when selling.  If you deduct your home office from federal income taxes when you sell you will be required to pay taxes on the portion of profits that equals any depreciation on the office you have been claiming prior.  To avoid having to do this, you have to cease using your home office space for a year or two prior to selling.  If you are in this situation, contact your tax advisor for more guidance.


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