Selling a home is a major life change. But before you can concentrate on buying a new house, you’ll need to figure out how to properly report any profits related to the sale of your house. Such profit is known as capital gains. This has the potential to affect your financial plan, as you may experience a large windfall of cash and extra taxes. Things to know include tax breaks, reduced exclusions, how to report your house sale on a tax return and how to determine the total profit of your home sale. It may be helpful to talk to a financial advisor before you sell your house.
What Are Capital Gains Taxes?
From personal items to investment products, almost all of your possessions are capital assets. That includes property like cars or real estate and investments like stocks or bonds. Let’s say you decide to sell one of these assets, such as your home. The profit you make from the sale can potentially incur a tax called a capital gains tax.
Long-term capital gains occur when you sell an asset that you’ve held for more than one calendar year. Short-term capital gains occur upon the sale of an asset that’s been held for less than a year. While tax rates vary, long-term capital gains are typically taxed less than short-term capital gains.
It’s important to note that capital gains taxes only kick in for realized gains. That means it applies once you sell the asset for more than its basis. If a gain is unrealized, meaning you still own the item, then this specific tax does not come into play.
The long-term capital gains tax rate varies between 0%, 15% and 20%. There are a few higher rates for particular items, but they don’t apply to a home sale. In contrast, short-term capital gains are taxed as normal income, which can be a much higher rate. Income tax rates vary between 12% and 37%.
Do You Have to Pay Taxes on the Sale of a House?
When you sell your house for more than you paid for it, you might have to pay capital gains tax. However, some situations may result in you paying very little or even nothing at all in taxes. If you are single and you lived in your house for two of the five years directly before the sale, the first $250,000 of any profit you make on the home is tax-free. The tax-free amount increases to $500,000 if you’re married and you and your spouse file a joint tax return.
It’s important to note that these figures refer to profit, not income. This means that the tax is based on the net amount after expenses that you gain from selling your house. So it does not mean the total amount of money you make from selling your house, but rather the difference between the original purchase price and the sale price.
In turn, if you sell your home for less than $250,000 above your buying price – and you’ve lived in your house for at least two of the previous five years – you won’t owe any taxes on the sale of your home.
How to Determine the Profit of Your Home Sale
This means, of course, that you’ll need to calculate the profit you’ve made from selling your home in order to determine if you’ll owe taxes on the sale of your home. This calculation isn’t as simple as subtracting the price you paid from your sale price though.
First, you’ll need to figure out the cost basis for your home. You’ll need to consider not only the total amount you spent to purchase the house but also how much you’ve spent on any additions or home improvements. So, for example, let’s say your original purchase price was $200,000 and you spent $20,000 on adding an extra room. You’ll then add $20,000 to your cost basis.
Next, take note of how much you sold your home for. You’ll then subtract any fees you paid, such as closing costs and realtor fees, from that amount. If you sold your home for $300,000 but paid $10,000 in fees, the total amount you earned on the sale of your home is $290,000.
Now, subtract your cost basis from the total amount of money you earned from the sale. In this case, that’s $290,000 minus $220,000, resulting in a profit of $70,000. Since that amount is less than $250,000, you wouldn’t owe any taxes on this home sale.
How to Qualify for Home Sale Tax Breaks
There are three basic requirements you must meet to qualify for a tax break. Here’s a breakdown of them:
- You must have owned the home you are selling for at least two years. If you’ve owned the home for less time, you do not qualify for the tax break.
- You must have used the home as your primary residence for at least two of the past five years. This means that second homes, such as vacation homes and pure rental properties, will likely not qualify for this tax break.
- You must not have used this tax break for the sale of another home within the past two years. This means that if you are trying to sell multiple properties, the tax break can only apply to one of your properties.
If you meet these qualifications, then you may be eligible for the tax break. As you can tell, this will heavily increase the benefits of selling your home for a profit.
Qualifying for a Reduced Home Sale Exclusion
A reduced exclusion, also known as a partial exclusion of gain, allows you to claim part of the tax break, even if you don’t meet all of the above requirements. If you have only lived in your home for one year, for instance, you could be exempt from just $125,000 of any profit you make from selling your home.
You must have a valid reason to qualify for a reduced exclusion, though. Valid reasons include changes in employment, changes in health or any other unforeseen circumstance that makes it necessary for you to sell your home sooner than anticipated.
Reporting Your Home Sale on Your Taxes
If your profit on your home sale is less than the exemption amount and you meet the other qualifications, you do not have to report your home sale on your tax return. If you exceed or don’t qualify the exemption, you will need to report your home sale. Any profit that exceeds or does not qualify for the exemption is taxed as a capital gain under Schedule D.
You will also need to report your home sale if you receive a Form 1099-S. This form is distributed when you make a home sale. That is unless you assure your real estate closing company that you will not owe taxes on your profit. If you receive a form even though you qualify for the exemption, this doesn’t necessarily mean you owe taxes. However, it does mean that you will have to report the sale.
While you may have to pay taxes on the sale of your home, chances are you won’t have to. If you meet a few simple requirements, up to $250,000 of profit on the sale of your home is tax-free. This figure jumps to $500,000 if you file jointly. If you don’t owe taxes, you don’t even need to list your home sale on your tax return. Any taxed profit falls under the capital gains guidelines.
Home Buying Tips
- When you’re navigating a big financial decision like buying a home, working with a financial advisor can be helpful. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- For guidance on state laws governing capital gains taxes, use SmartAsset’s free guide to capital gains tax rates by state.
- Trying to figure out how much you can reasonably spend on a house? Use SmartAsset’s home affordability calculator. This takes into account your annual income, including your debt payments, to determine how much house you can afford.
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