As I have worked in public accounting over the past few years, I have found that my clients often have similar questions for me. Today I want to address one of those often repeated questions. How much tax will I have to pay when I sell my home?
First, let's start out with how the IRS determines what your gain is on the sale of your home. The formula is as follows:
Selling Price of Main Home
Minus: Commissions and other expenses of sale
Minus: Basis of Residence Sold
Gain on Sale of home
Selling Price & Commissions/Expenses
Now let's break that down. The first two items, selling price and commission expenses are pretty straightforward. You can get that from your real estate broker.
Basis of Residence Sold
The basis of your residence is the value of your home in the eyes of the IRS. The basis is determined primarily by how you received the home. Below are some common examples.
If you bought the home, your basis in the home is the price you paid for it, i.e. the cost
If you built your home, it is the cost to build it
If you inherited or were gifted the home, your basis is either the fair market value or adjusted basis of the previous owner
Important to note is that while owning the home, you may have made several improvements to the home that increased its value. Such improvements will increase the basis in your home, thus reducing the potential gain on the sale. Only the actual cost for the improvements can be added to the basis.
To be considered by the IRS as a qualified home improvement, one of the following three items must be met. The improvement must either
Here are some examples of applicable improvements.
Exclusion of Gain on the Sale of Your Home
Tax law allows you to exclude a certain amount of profit from the sale of your residence. The amounts for this are dependent on the status under which you file your taxes.
If you file as a single taxpayer, you may qualify to exclude up to $250,000
If you file married filing jointly, you may qualify to exclude up to $500,000
Ownership & Use Tests
You do need to qualify to take advantage of this tax exclusion rule. To qualify, you must meet the Ownership and Use Tests.
During the 5-year period ending on the date of sale:
You must have owned the home for at least 2 years
You must have lived in the home as your main personal residence for at least 2 years
Do I need to report the gain, even if it is all excludable?
The answer is YES! If you receive a Form 1099-S, “Proceeds from Real Estate Transactions,” you must report the sale even if the gain on the sale of your home is entirely excludable.
Here is a simplified example based on work I did for one of our clients.
Mr. and Mrs. Stevens (not the actual client name) sold their house for $900,000. Their broker’s commission and expenses came to $50,000. They purchased the house for $275,000 and spent $25,000 on qualified home improvements. They file their taxes jointly.
Married Filing Jointly Scenario
Selling Price of Main Home
In this example, the Stevens owed capital gain taxes on $50,000.
These are the main factors to consider when you are in the process of selling your home. A person’s home is often times his/her most valuable capital asset. We want to make sure that, as taxpayers, we are taking advantage of all the tax savings we can, by being aware of the factors mentioned above. If you have any questions, comment below or reach out to us.
Emily Tafua is a senior accountant at Milam, Knecht & Warner, LLP. She has a bachelor's degree in accounting from Brigham Young University and has been with MKW for three years. Outside of work, Emily enjoys reading a good book, hiking, and taking small getaways with her husband.