Just as there are tax benefits to buying a home, there are ways to lower your tax liability as a seller.
However, instead of getting another deduction to mark down when you file, you can avoid paying capital gains tax on your sale. If you qualify for this exemption, you can maximize the amount you earn from the transaction. After paying a commission to your selling agent, settling on closing costs and carrying out a pre listing home inspection, it'll be nice to see less of the money you get for your home going into pockets besides your own.
Here are the criteria to qualify for a capital gains tax exemption:
- Your capital gains cannot be more than $250,000 when filing your taxes as an individual or $500,000 when filing jointly.
- If you are married, you and your spouse cannot have used this exemption within the two years preceding the sale.
- You must have lived in the home for two of the past five years. These years don't have to be consecutive or the past two of the last five years, and you're not required to live in the property on the date of the sale.
- The home has to be your principal residence, as opposed to a vacation or second home.
Why is the capital gains tax exemption beneficial?
Prior to the introduction of the Taxpayer Relief Act of 1997, you were allowed to get a tax exemption when selling your home, but there was one caveat: Within two years, the profits had to be used for the purchase of another property that was more expensive. Additionally, those who were 55 or older could get a one-time exemption up to $125,000. There was also a tax form to complete, which would prove that you acted within the rules.
Under the current law, you can use your profits for whatever you choose, which is beneficial for retiring individuals who are looking to downsize to a smaller property and add the funds from their home sale to their nest egg.
What are capital gains?
To determine whether you qualify for the exemption, you must have an understanding of what capital gains are. In regard to your home, the calculation is not as simple as subtracting the price you bought the home for from the sale price. Instead, take the sale price and subtract the selling expenses, deductible closing costs and your tax basis in the home. The last variable has its own equation: the original purchase price plus the purchase expenses, minus depreciation, the cost of capital improvements and insurance payments or casualty losses.
The figure you arrive at after all the adding and/or subtracting will tell you whether you're within bounds for the capital gains exemption.
Special considerations for married owners
There's no clear time for when you should meet the person you plan to spend the rest of your life with, and you could start a relationship with that individual after you've become a homeowner. However, this doesn't mean you two can't qualify for the joint exemption of $500,000 if you get married and want to sell the property to move into a bigger place and start a family. As long as you meet the requirements as the homeowner, it doesn't matter that you added your spouse to the title at such a time that he or she didn't qualify. The one factor that still applies to both of you is the use requirement. Both of you must have lived in the property for two of the past five years.