Homeowners already know the many tax breaks that Uncle Sam offers, most notably mortgage interest and property tax deductions. Well, he also has good tax news for home sellers: Most of them won’t owe the Internal Revenue Service a single dime.
When you sell your primary residence, you can make up to $250,000 in profit if you’re a single owner, twice that if you’re married, and not owe any capital gains taxes.
?Most people are not going to have a tax obligation unless their gain is huge,? says Robert Trinz, senior analyst with Thomson Reuters Checkpoint.
What is capital gains tax?
Capital gains tax, or CGT, is a tax imposed on the profit (capital gains) resulting from the sale of an investment. For example, capital gains are commonly realized after the sale of stocks and property. To calculate capital gain, subtract the purchase price from the sales price.
Sale price ? purchase price = capital gain
Some sellers are surprised by this break, especially if they?ve been in their homes for a while. That’s because before May 7, 1997, the only way you could avoid paying taxes on your home-sale profit was to use the money to buy another, more-expensive house within two years. Sellers age 55 or older had one other option. They could take a once-in-a-lifetime tax exemption of up to $125,000 in profits. And in all instances, there was Form 2119 to fill out to show that you followed the rules.
But when the Taxpayer Relief Act of 1997 became law, the home-sale tax burden eased for millions of residential taxpayers. The rollover or once-in-a-lifetime options were replaced with the current per-sale exclusion amounts.
?There is some logic to this law change because most people under the prior rules didn’t recognize a taxable gain, because they rolled it over into another residence,? says Trinz. ?The change essentially makes it easier to dispose of your residence.?
Still some requirements to meet
If you used pre-1997 rules for residential sales, don’t worry. That doesn’t disqualify you from claiming the exclusion on any residential sales now. The law change applies to all sales since it took effect.
Another bonus to the changed rules? You don’t have to buy another home with your sale proceeds. You can squander the money any way you like.
Even better, there’s no limit on the number of times you can use the home-sale exemption. In most cases, you can make tax-free profits of $250,000, or $500,000 depending on your filing status, every time you sell a home.
There are a few rules to follow, of course. First, the property you’re selling must be your principal residence. That means you live in it. This tax break doesn’t apply to a house or other property that you have solely for investment purposes. In those cases, the usual capital gains rules apply.
You also must live in that principal residence for two of the five years before you sell it. This is known as the use test. It also means, practically speaking, each sale must be at least two years apart.
That still leaves you room to make some money on several properties. You can sell your residence this year, pocket any gain within the tax limits and buy a new residence. Then two years later, you can do the same thing, again and again, every two years.
And you no longer have to worry about that pesky prior-law reporting requirement. When your gain doesn’t exceed the limit, you don’t have to file anything with the IRS.