Your home is probably your most valuable asset, and if you hold a large amount of equity in it, selling your home can be an easy way to generate cash quickly. But what if you have owned the home for a while and stand to make a substantial profit on the sale? Will you owe federal income taxes on the profit you make on the sale? Well that depends. Is this the home you have lived in for years? Or is it a rental property? Maybe you lived in it for a while and moved to a larger home but kept it and rented it out? Property owners selling their homes must know the rules about home sales and taxes in order to maximize the benefits of selling. Here’s what you should know about tax liabilities when selling your home.
Tax-Free Sales Profits
The good news is that the Internal Revenue Service doesn’t tax the profits you make from selling your primary residence. You qualify for this tax break if you lived in the home as your primary residence for at least two years in the five years prior to selling. If these conditions are met, the first $250,000 of profits are tax-free! The untaxable amount increases to $500,000 if you’re married and file a joint tax return. That is a nice little tax break!
Reporting the Sale on Your Tax Return
If you meet the requirements for excluding your profits on the home’s sale, you generally don’t even need to report the proceeds of the sale on your tax return. You can just take your profits and walk away! If the criteria are not met and the gains on the sale of your home are taxable, you must complete Form 1099-S: Proceeds from Real Estate Transaction and include it with your federal income tax return for the year of the sale. IRS publication 523, Selling Your Home, has interactive forms that can help you determine if you are eligible for the capital gains tax exemption. If you aren’t sure if the sale of your home requires that you complete a Form 1099-S, consult the IRS or a tax preparation professional.
Capital Gains Taxes
In the event that you don’t meet the residency requirements for exemption, you will owe taxes on any capital gains on the sale of your home. If you do meet the requirements for exemption, but your profits exceed the $250,000/$500,000 limit, you will pay capital gains taxes on the portion of the gain over that exceeds the limit. Additionally, if you owned the home for less than one year, you’ll pay taxes on the profits you made in the sale at your regular tax rate, according to your income. To calculate the taxable gain, first calculate your cost basis of the home. This is what you paid for the home, plus any permanent improvements you’ve made such as remodeling, an addition, a new fence, new built-in appliances, etc. Then subtract this cost basis plus any allowed closing expenses and real estate agent commissions from the total sale price.
Note that some exceptions exist to the two-year rule for property owners who are tax-exempt. If you’ve recently become disabled, you need to move for medical treatment or to care for a relative, or if you must sell because of a job relocation at least 50 miles from your current property, you might have the option to prorate the capital gains taxes on the sale of your home. Consulting with the IRS and a tax professional can help you discover if you qualify for a two-year-rule exemption on your taxes.