Capital Gains Tax from Selling Your Home: Myths vs. Reality

Capital gains is the income made from selling capital assets, including real estate, for more than their basis.  If you are a homeowner looking to sell your home during these peak real estate times, what does this mean for you and your taxes? 

This is a question that many are asking, but is often misunderstood.

 Myth 1:

I won’t have to pay capital gains tax on the sale of my home because gain is not recognized on the sale of a primary residence.

Reality 1:

So, you sold your home for more than you paid for it- this is good news! The downside to this is that you have a capital gain, and you might have to pay a capital gains tax. Each individual may be eligible for a $250,000 tax free exemption on capital gains from a primary residence, but anything over this threshold will be taxable.

Myth 2:

I am selling one of my homes- I will automatically receive a $250k exemption on my capital gains.

Reality 2:

Not every individual will qualify for the $250,000 exemption when they sell their home. In order to meet the eligibility requirements, you must answer yes to the following questions:

• Have you owned the home for at least 24 months out of the last 5 years?
• Have you used your home as your primary residence for at least 24 months of the previous 5 years?
• Is this the only home that you have sold in the past 2 years where you have taken this exclusion?

If you are selling a home that has not not been used as your primary residence for at least 24 months of the previous 5 years, you will not qualify for the full amount of the exemption, or any depending upon the facts and circumstances..

Myth 3:

Even if you fail to meet the eligibility requirements for the exemption, you may be eligible for a partial exclusion for capital gains tax. The IRS states that “You can meet the requirements for a partial exclusion if the main reason for your home sale was a change in workplace location, a health issue, or an unforeseeable event.” Click here to see Publication 523 for more details.

Myth 4:

I just got married- we can now sell my house and receive a $500,000 exclusion from capital gains.

Reality 4:

It is true that once married, a couple becomes eligible for a $500,000 exemption on their capital gains, but specific requirements apply. In order to qualify, only one spouse needs to claim ownership of the home, but both spouses must have:

• lived in the home for at least two of the past five years.
• Not taken this exclusion in the past two years.

If one spouse has not lived in the home or has already taken the exclusion in the previous 2 years, they will not be eligible for the full 500,000 exclusion.

Myth 5: 

My spouse and I bought a house for $200,000 and now we are selling it for $750,000, so that is $550,000 of capital gain, and this is $50,000 over the threshold of our exclusion.

Reality 5: 

Many people are under the misconception that their gain on the sale of their home will simply equal the profit they receive on the sale. Usually, the capital gain calculation on the sale of your home is not this simple- and this can be for your benefit. 

Capital gain is calculated by taking your home’s selling price and deducting any selling and closing costs.  You would then deduct the cost basis of your home. The basis of your home does not just include the purchase price, but also costs of capital improvements that you made (e.g. the new roof you added in prior years, new plumbing, or the new remodeling of the bathroom, etc.). This means that any cost contributed to the value that you put into your home can be added to your basis and ultimately deducted from the selling price- resulting in a lower amount of capital gain income.

Let’s say that in this example, you and your spouse bought a house for $200,000 and sold it for $750,000, but you paid the broker $15,000, spent $30,000 on home improvements, and spent $5,000 on getting the home ready for sale. These costs combined with the $500,000 exclusion would mean that you wouldn’t have to pay tax on any capital gains made on the sale of your home. Much better, right?

In summary, the best way to know with certainty, whether or not you will have a capital gains tax on profits made from the sale of your primary residence and your IRS reporting requirements are to work with your tax professional.

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