Tax Consequences of Selling Your Home

Much has been written about the 1997 tax law change that allows home sellers to exclude a significant amount of their capital gains from taxation. It is no longer necessary (as it once was) to buy a more-expensive home toavoid capital gains tax on profits from a home sale. Now, up to $500,000 (for married taxpayers) or $250,000 (for singles) in profits can be excluded from taxation whether you buy a bigger home, a smaller home, or any home at all.

There are, however, a few rules:

1. You must have owned the house for at least two of the five years prior to the sale.
2. You must have used the home as your principal residence for a total of two of the previous five years. Any two years qualify, including intermittent, non-consecutive periods of time.
3. You must wait two years between home sales that claim the exclusion.

If a homeowner must sell a principal residence before the two-year qualification is met due to a change in place of employment, health, or unforeseen circumstances, the homeowner may take a prorated portion of the exclusion. (Please consult with a tax professional if this applies to you.)

Capital Gains

The profit you make when selling a home qualifies as a “capital gain.” Uncle Sam may be able to get some of your gains if you don’t qualify for the exclusions stated above or if your gains exceed the limits.

To compute your capital gain, you must first know your home’s “basis value” — your costs to acquire the home plus or minus any “adjustments”

Acquisition Costs

Of course, the starting point of your home’s basis value is the price you paid for it. But purchasing costs also include most settlement or closing costs you paid, such as fees for title insurance, legal service, recording fees, surveys, transfer taxes, abstract of title, and more. You cannot, however, include fire insurance premiums, rent to occupy the home prior to settlement, mortgage insurance premiums or loan-acquisition costs (such as discount points or credit reports). Nor can you include escrowed amounts for future payment of taxes or insurance.

Adjustments To Basis

You may add certain items to your home’s cost basis and you must subtract certain other items from it. The higher the basis value, the lower your capital gains tax liability will be.

Increases to basis include:

•  The cost of “capital” improvements to your home (e.g., putting on an addition, replacing the entire roof, paving the driveway, installing air conditioning, etc., but not home maintenance or repair expenses)
• Assessments for local improvements
• Amounts spent to restore damaged property

Items that decrease your basis include:

• Insurance reimbursement for casualty losses
• Deductible casualty loss not covered by insurance
• Payment received for granting an easement or right-of-way
• Depreciation deduction for use of your home for business or as a rental property
• Value of energy conservation subsidy
• Points paid by the seller
• Gains deferred on sale of a home before May 7, 1997.

For detailed information on these basis issues, consult a tax professional or refer to IRS Publication 523, Chapter 2.

Home-Sale Proceeds

Next, you’ll need to compute the proceeds from your home sale, which equal the sales price minus your selling expenses. Note that selling expenses include broker’s commissions and legal fees. They also include expenses that would otherwise be considered repairs if they were incurred to make the home more saleable and the repairs were completed within 90 days of the sale.

The Calculation

Now you’re ready to do the math. Subtract your home’s adjusted basis value from your home-sale proceeds. The answer is your capital gain amount. If it’s over the $250,000 or $500,000 limits, you’ll have some taxes to pay.

A Note To Refinancers

If you’ve paid loan points to refinance your home, you weren’t allowed to deduct all those points on that year’s tax return. When refinancing, the tax law requires that you amortize any points paid over the life of the new loan. (On a 30-year loan, you could deduct 1/30th of the points you paid each year.) If you still haven’t deducted the full value of those points by the time you sell your home, you can deduct all the remaining points during the tax year of the sale.

Be sure to consult a tax professional for complete and up-to-date information