Due to the economic impacts of COVID-19, the novel coronavirus, many individuals have begun reassessing their personal finances including their asset holdings. Some of this reassessment has occurred due to loss of income or simply accelerating future plans. One of these considerations has been selling one’s personal home. However, when selling your home, or any asset, you need to consider the tax implications of such a transaction. Now, the IRS provides some tax breaks and techniques that minimize or even eliminate the income tax burden of selling your home. However, you must follow the rules. Below are some rules and considerations you may be able to use to assist you in reducing or eliminating the tax impact of selling your home.
First, if you are selling your primary residence remember you can only be taxed on the sale price of the home, less the amount you originally paid for the home plus closing costs, and any improvements, this is known as your basis. (However, the basis could also be fair market value if you inherited the property which is known as a stepped-up basis.) But, what counts as improvements? Any expense that improves the value of the home. Examples of improvements include adding a pool, renovating your kitchen, or adding a bedroom. It should be noted, repairs for fixing damages to your home are not considered improvements and cannot be used. Also, if you were able to claim casualty; theft; and losses on a previous tax return with respect to your home, please note such amounts would reduce the basis that would offset the sales price amount for taxation.
Of course, you can potentially avoid paying taxes on the gain if you have lived in your home for at least 2 years within a 5 year period. The amounts you can avoid paying taxes on depends on your filing status. For Single filers, you can avoid paying tax exclusion up to 250,000 of gain on the sale of your primary residence. For married filing jointly, you can exclude paying taxes on up to 500,000 of gain on the sale of your primary residence.
However, what if you sell your primary residence and did not meet the requirements of living in the home for 2 years in a 5 year period? Do you still qualify? You may still qualify to avoid paying taxes on your primary residence, albeit at a reduced amount. Though, in order to qualify, you must have one of the following scenarios: had a change in employment, change in health, and unforeseen circumstances such as a divorce or needing a larger home due to having a child or more children.
Currently, the reduced amount for tax purposes reduces the exclusion amount (250,000 for single, 500,000 for married filing jointly) based on the time the taxpayer actually lived in the home.
For instance, if a married couple filing a joint return is required to move for employment but only lived in their home for a year, they can deduct 250,000 (1/2 of 500,000 since the time they lived in the home was half of the required two year amount) of any gain from the sale of the primary residence.
Obviously, considering the law regarding avoiding taxes on the sale of your primary residence, it is possible to have two different homes qualify as a primary residence within a five (5) year period and take advantage of this for two different homes. So, can someone actually take advantage of the law for two different homes within a 5 year period? The answer is yes but likely with limitations. Homes sold before 2008 would have been able to fully take the deduction without limitations. Conversely, properties sold after 2008 would have a limitation that is computed by dividing the amount of time the home was used as a residence by the total time the property was owned by the taxpayer. For example, if you are married filing jointly and owned a second home for 10 years and made the second home your main home for the last 5 years before selling the property, you would be taxed 50 percent (50%) of the gain on the sale. The remaining gain would qualify for the tax exclusion of 500,000.
If you are considering selling or otherwise divesting any of your assets and want to be sure you are limiting your tax exposure, give us a call. We would be glad to answer any questions you may have.