Tax Consequences of Selling a House
Most people are familiar with the concept of having to pay capital gains tax on the profits from the sale of a house if the sale meets certain conditions. If you aren’t familiar with them, the standard rules are that single people can exclude $250,000 of profit from the sale of house from taxes; married or unmarried people who jointly own can exclude $500,000.
For example, a single person who made $300,000 on the sale of a house would be responsible for paying taxes on only $50,000. Married people or other joint owners realizing $300,000 profit would pay no taxes since their exclusion is $500,000.
Of course, these rules apply only if you meet what the IRS calls the “usage test.” To qualify for these exemptions, you must have used the house as your principle residence for at least two of the last five years before the sale. They don’t have to be two consecutive years. This means that if you’re selling a vacation home or you haven’t lived in the home for a total of two years, you must pay taxes on the profit, or capital gain.
How much is the gain?
You might think that a person who paid $200,000 for a house and sold it for $300,000 would have a gain of $100,000, but that's not the case. To calculate capital gains, you deduct your tax basis on the house and deductible selling and closing costs from the sales price.
Sales Price – Deductible Selling/Closing Costs – Your Tax Basis = Capital Gains
Deductible closing costs include any mortgage points, pre-paid interest, or pro-rated property taxes you pay at closing. Broker commissions, title fees, legal costs, etc. are deductible selling costs.
Understanding the tax basis is a bit more complicated. Many people assume the tax basis is simply the amount they paid for the house. But capital improvements add to your basis, so if you’ve done some remodeling, your basis has increased. Your tax basis is calculated by adding purchase expenses and the cost of capital improvements to your purchase price, and subtracting any depreciation.
Purchase Price + Purchase Expenses + Capital Improvements – Depreciation = Tax Basis
Exceptions and partial exclusions
If you haven't lived in your house for two of the last five years, you can still get a portion of that exclusion. If you had an extended stay or a permanent move to a nursing home, the usage test is lowered. In these cases, you can claim the exclusion as long as you lived in your house for one of the last five years.
You may also be entitled to a partial exclusion if you must sell due to a change of employment, a doctor recommended move for health reasons, divorce, or because other qualified unforeseen circumstances have arisen. This might include such things as the death of a spouse or multiple births. If any of these things happened, you can calculate your exclusion by dividing the number of months you lived in the house by 24 (the number of months required for a full exclusion).
If you have taken depreciation on the house for use of a home office, you should be aware that the amount of depreciation is not added to the exclusion, and you will have to pay taxes on the depreciation you have claimed.
If you’ve been thinking of selling your house and are concerned about the tax consequences, you should consult a qualified tax professional to make sure you follow the rules and know what you're getting into before you do it.