Smiling couple stands in front of sold house
Dabl At Home Dec 2020
Presented By
Dabl at Home

Here’s Why You Have To Consider Capital Gains Taxes Before Selling Your Home

Learn how to avoid paying costly capital gains taxes when selling your home in 2021!

If you’re a homeowner, you’ve likely seen your home’s value skyrocket over the past year or so.  Thanks to a significant shortage of decent homes available on the market and historically low interest rates, many homeowners have decided that now is the time to list their homes to maximize their profits. While selling one’s home isn’t a decision to be taken lightly, many homeowners forget to consider how they may be impacted by capital gains taxes. 

Your home is considered a capital asset, so when you put your home on the market, the IRS may come looking for a piece of the profits. Essentially, the IRS and some States will levy taxes, known as capital gains taxes, on the difference between what you pay to acquire an asset and the money made when it’s sold. If your home has appreciated in value, you may be required to pay taxes on the profit. That said, there are a few ways in which you could be exempt from capital gains taxes and can maximize your profits from the sale of your home. If you’re considering listing your home, make sure to ask yourself the questions below and consult with a tax professional in your area who can give you specific advice for your situation. 

How long have you lived in your home? 

Have you been the primary resident living in your home for at least two of the last five years? If the answer is yes, you may be exempt from paying capital gains taxes. Those two years don’t need to be consecutive, but the home needs to be your primary residence for at least two of the last five years for the exemption to apply. Note that you can only use this exemption rule once every two years, so if you are planning to sell multiple homes at the same time, you will only be able to use the exemption for one property. 

Are you single or married?

Depending on your marital status, the amount of the profit from the sale of your home that can be excluded from capital gains taxes will vary. In general, the IRS allows single people to exclude up to $250,000 of capital gains on the sale of their primary residence. Married couples who file jointly are typically able to exclude up to $500,000. 

Do you qualify for an exemption due to special circumstances?

Depending on your circumstances, you may be able to get a break on capital gains taxes. For example, military personnel, people who work in Foreign Intelligence or in the intelligence community, and disabled residents may be given exceptions to the rule that requires them to live in the residence for two years. Military personnel who have been on extended duty can also defer the five-year requirement for up to ten years, which means that military personnel are eligible for the tax break as long as they’ve lived in their home for two out of the last fifteen years. Special consideration is also given in cases where major life events have occurred, such as a divorce or a diagnosis of a serious medical condition. 

What is your cost basis?

The cost basis for your home is the sum of the price you paid to purchase it and the cost of the home improvement measures you’ve taken. Make sure to save receipts from improvement and remodeling projects, which can include anything from home expansions, new windows, installing a new air conditioning unit, landscaping, and more. When you have a higher cost basis, your exposure to capital gains taxes may be lower or even non-existent. 

You will also need to consider any special circumstances that could impact your home’s cost basis, and what it means when it’s time to pay taxes. In an event where you are given money to put back into your home, your exposure to capital gains may be higher. For example, if a fire occurred and the insurance company paid you to fix the damages, the money they paid you would reduce your cost basis. If you inherited a home from a deceased relative or friend, your cost basis will be the value of the home at the time of your loved one’s death and not at the time the home was originally purchased. These inheritance laws vary from State to State, so again consult your local tax advisor. 

Should you do a 1031 exchange instead?

If you are not eligible for any tax exemptions on the sale of your home, you may be better off completing a 1031 exchange rather than trying to look for loopholes. In a 1031 exchange, you are essentially reinvesting the profits from the sale of your home into a similar property. The 1031 exchange allows for the capital gain taxes from the sale of the first property to be deferred, rather than eliminated. In addition, this transaction is typically only allowed when purchasing investment properties or business properties that are not meant for personal use. Make sure to consult a local tax professional in order to determine if a 1031 exchange is right for you. 

When is a home sale considered fully taxable?

If your home sale is not currently tax exempt, you will have to determine if you will still earn enough profit from the sale of your home after taxes to justify putting it on the market. If you have the ability to wait, your home sale may become eligible for a tax exemption at a later date. However, you will run the risk of market conditions changing for better or for worse. Here are some conditions where your home sale would be subject to capital gains taxes:

-The home is not your principal residence,or has not been your primary residence for two of the last five years. 
-The property was acquired using a 1031 exchange in the last five years. 
-You sold another home within the last two years and used the capital gains tax exclusions at that time, which makes you ineligible to use capital gains expenses at this time. 

As you can see, determining your eligibility for tax exemptions as well as your home’s cost basis is a complicated process. However, understanding how capital gains taxes will impact the sale of your home is crucial for determining if now is the right time to sell and if you will get a sufficient or maximum return on your investment in your home. Once again, we always recommend receiving guidance from qualified tax professionals and/or real estate experts in your area so you know exactly where you stand.

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