Many home owners are not aware that they may owe capital gains tax on the sale of their home when it comes time to file their federal tax return. With capital gains tax rate reaching up to 20%, this could be an unwelcome surprise. There are ways, however, to avoid paying capital gains tax. Sellers should be careful to note the details of these exclusions.
What Is Capital Gains Tax?
Simply put, the capital gain on the sale of a home is the profit earned on the sale. A more detailed explanation is that the capital gain is the difference between your selling price and your current basis in the home. Your basis is the original purchase price plus expenses plus the cost of capital improvements minus depreciation, casualty loss, and insurance. Unless the seller qualifies for a tax exemption on the sale, he will pay capital gains tax on this amount.
Capital Gain = Selling Price – (Purchase Price+Expenses+Cost of Capital Improvements)-(Depreciation+Casualty Loss+Insurance)
Capital Gains Tax Exclusion
Under certain circumstances, sellers are able to avoid paying some or all of the capital gains tax. Home owners can exclude up to $250,00 of the capital gain if they are single and up to $500,000 of the capital gain if they are a married couple filing their taxes jointly. To qualify for this capital gains tax exclusion they must meet the requirements of three specific exclusion rules.
Rule #1 – The home must be a primary residence.
Rule #2 – You must own the home for at least two years.
Rule #3 – You must live in the home for at least two of the past five years.
Did you sell a home this year? Have you ever been surprised by your tax bill after selling a home in the prior year?