Given the dramatic rise in property values over the last several years in Southeastern Minnesota, your home has probably appreciated in value. However, there’s a good chance that the profit from your home sale will not be taxable. Unmarried individuals can exclude up to $250,000 in profits from capital gains tax when they sell their primary personal residences, thanks to a home sales exclusion provided for by the Internal Revenue Code. Married taxpayers can exclude up to $500,000 in gains.
The tax break is the Section 121 Exclusion, which is commonly referred to as the home sale exclusion. This rule makes your capital gain or loss the difference between the sales price and your basis in property — what you paid — plus certain qualifying costs.
To calculate your gain, subtract your cost basis from your sales price. Find your cost basis by starting with what you paid for the home, then add the costs you incurred in the purchase, such as title fees, escrow fees and real estate agent commissions. Add the costs of any major improvements you made, such as replacing the roof or the furnace. Minor renovations such as painting a room don’t count. Subtract any accumulated depreciation you may have taken over the years — if you’ve ever taken a home office deduction, that would factor into the depreciation. The resulting number is your cost basis.
Your capital gain is the sales price of your home minus your cost basis. You’ve got a loss if the number is negative. You can’t claim a deduction for a loss from the sale of your main home or for any other personal property.
You’ve made a profit if the capital gain is positive. If the property is your primary residence, you can subtract the home sales exclusion to find your taxable gain. To be eligible for that break, you must have lived in the home for a minimum of two of the five years immediately preceding the date of sale. The two years don’t have to be consecutive, and you don’t have to live there on the date of the sale.
You can use this two-out-of-five-years rule to exclude your profits each time you sell your main home. However, you can claim the exclusion only once every two years because you must spend at least that much time in residence. You can’t have excluded the gain on another home in the last two-year period.
You also want to document any unforeseen circumstances that might force you to sell your home before you’ve lived there the required period of time. The IRS defines an unforeseen circumstance as an event that you couldn’t reasonably have anticipated before buying and occupying your main home. Natural disasters, a change in employment that left you unable to meet basic living expenses, death, divorce and multiple births from the same pregnancy qualify as unforeseen circumstances under IRS rules. Any unforeseen circumstances may get you a partial exclusion.
Active-duty service members aren’t subject to the residency rule. They can waive the rule for up to 10 years if they’re on qualified official extended duty.
Any profit from the sale of your home is reported on Schedule D as a capital gain if you realize a profit in excess of the exclusion amounts or if you don’t qualify for the exclusion.
This is just a summary — there may be other provisions and exceptions applicable to you. Be sure to consult your tax professional before filing.
Also, this article only applies to the sale of a homestead. If you are buying or selling a business property you will not be eligible for a 121 exclusion. You may, however, want to consider a 1031 exchange in certain circumstances. Contact us to learn more.