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Selling Your Home? Understand How Capital Gains Taxes Will Factor In

May 21, 2024

Hoping to sell your home this summer? You will want to review some key considerations regarding capital gains taxes. Don’t miss out on the chance to minimize your tax liabilities! Read on.

Putting your house on the market? You can typically exclude up to $250,000 of capital gains (up to $500,000 for married filing jointly) if you have owned your home and used it as your main residence for at least two of the five years prior to selling. Let’s explore this benefit.

The gain exclusion rules:

If you’re selling a house that’s increased substantially in value from when you bought it, you should take advantage of the home sale gain exclusion. If you qualify for this tax break, all or a large part of the profit from selling your principal residence will be free from federal income taxes, and generally state income taxes as well.

Capital gains taxes are taxes levied on profits from the sale of an investment, which includes a principal residence.

  • A short-term capital gain results from the sale of an asset owned for one year or less. Short-term gains are subject to taxation as ordinary income and do not benefit from any special tax rates or treatment.
  • A long-term capital gain results from the sale of an asset owned for more than one year. Long-term capital gains are subject to a 0, 15 or 20% federal tax rate, depending on your income level in the year of recognition.
  • In either case, when adjusted gross income (AGI) is above certain levels ($250,000 for married, filing joint), capital gains are normally also subject to the 3.8% Net Investment Income tax.

A single homeowner can potentially sell a principal residence for a gain of up to $250,000 without owing any federal income tax. If you’re married and file jointly, you can potentially pay no tax on up to $500,000 of gain. You must pass two tests to qualify, however:

  1. Ownership test- You must have owned the property for at least two years during the five year period ending on the sale date. (For the joint filer exclusion, at least one spouse must pass.)
  2. Use test- You must have used the property as a principal residence for at least two years during that same five year period. (For the joint filer exclusion, both spouses must pass this).

Are there exceptions to the eligibility test allowed?

Yes, if you do not meet the above requirements, special rules may allow you to claim a partial or full exclusion. This includes:

  • Temporary Absences: Short temporary absences from the home can still count towards meeting the residency requirement, even if you rented out the property during these times.
  • Transfers due to Divorce: If you transfer your home (or your share of a jointly owned home) to a spouse as part of a divorce settlement, you are considered to have no gain or loss.
  • Divorce Settlements: If you receive ownership of a home through a divorce settlement, you can include the time the home was owned by your ex-spouse when calculating how long you've owned the home, however, you must meet the use test on your own.
  • Divorce or Separation Agreements: If you or your spouse is granted use of the home through a divorce or separation agreement, the spouse not residing in the home can still count the days the other spouse lived there towards the ownership-and-use test.
  • Deceased Spouse: If one spouse dies and the surviving spouse hasn't remarried before the home is sold, the surviving spouse can include the period the deceased spouse owned and used the property when determining eligibility. In addition, if the sale is within 2 years of the death of your spouse, you may be able to increase your exclusion to the $500,000 joint exclusion.
  • Long term care facility: If you lived in the residence as your main home for at least 1 year out of the last 5 years, up to 1 additional year may count towards the 2 year use test if you lived in a licensed care facility during that time.
  • Members of the military: You can delay the five-year ownership and use test for up to ten years if you or your spouse serve on "qualified extended duty," which includes being stationed over 50 miles away from your main home for over 90 days or residing in government housing under official orders, allowing you to meet the two-year use test even if you didn't physically live in your home for the required period.

In addition, there are partial exclusions available if you don’t fully meet the eligibility tests, including:

  • Work related move: You changed jobs before meeting the 2 year period to a location that is more than 50 miles further from your house than your current job.
  • Health related move: You moved to obtain or provide medical care for yourself or certain family members suffering from a disease, illness or injury before meeting the 2 year test.
  • Unforeseeable events: Including among other things, giving birth to two or more children from the same pregnancy.
June Landry CTA

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