Worth anywhere from hundreds of thousands to millions of dollars, your home is likely one of the most expensive things you own. It’s also one of the most lucrative sales you can make.
If you take advantage of a seller’s market or make significant renovations to your home, you could make a significant profit by selling it. This profit will be considered as capital gain.
Homes are considered as capital assets because they’re a significant piece of property. If you sell a home for more than you paid, you’ll need to report your capital gain to the IRS and you’ll be taxed for your profit on the sale through the capital gains tax. Keep in mind this is only related to federal taxes, not state (which in CA there is additional)!
However, you may be able to sell your home and avoid paying the capital gains tax by qualifying for an exemption.
What is Exempt if You Qualify
If you qualify, the amount you can exclude depends on your filing status. Those filing as single qualify for up to $250,000 and married couples filing jointly can exempt up to $500,000.
Make sure to keep a detailed record of how much you bought your home for. Your capital gains will be the price you paid for the home subtracted from the sale price of the home. CFO of FraimCPA David Cawley gives this example:
Let’s say a couple bought a home in 2010 for $150,000 and owned and lived in it until they decided to take advantage of a seller’s market and sold it for $250,000 in 2018. Their ‘gain’ on their house would be $100,000, which would have no tax implications because they met all the requirements for capital gain exclusion, and the gain can be left off their tax return altogether.
Follow These Guidelines to Qualify for Exemption
Keep Your Home and Live in it Longer
To be able to qualify for exemption, you need to have owned your home for at least two years, and you need to have used it as your primary place of residence for at least two years. The two years that you live in the home you want to sell don’t need to be consecutive.
Keeping your capital asset longer also affects the way you’re taxed. If you own an asset for less than a year, it is considered a short-term capital gain, and your tax rate is equal to your tax bracket.
If you keep your capital asset for a year or more, it is considered a long-term capital gain. Depending on your tax bracket, you could end up paying nothing. With higher income, you may pay 15% to 20%.
Cawley recommends taking advantage of long-term options, stating, ” Long-term gains are always taxed at lower rates than short-term gains, so holding the assets for more than a year will always be the most advantageous tax maneuver.”
Don’t Sell One Home Too Quickly After Another
Following the two-year rule applied to owning and living in the home, you also aren’t qualified for exemption if you’ve exempted the gains on another home sale in the last two years.
Even though you need to wait a few years between sales, there may be no limit to the number of times that you can exempt your gains as long as you wait the appropriate amount of time.
If you are married and file jointly, this qualification applies to both you and your partner.