With persistent inflation driving up the cost of just about everything, particularly home values, people are often surprised when they receive a 1099-S and find out they may have to pay capital gains on the sale of their home. Today’s rules are a result of the Taxpayer Relief Act of 1997.
According to the law, you can exclude up to $250,000 ($500,000 if married) worth of profit when selling your primary residence. Profit being defined as the sale price minus the price you paid plus the cost of any improvements made to the home (so keep receipts when you make home improvements).
However, there are some stipulations. You can only use the exemption on your primary residence and not a vacation home or rental property. There is a residency requirement as well where you must have lived in the home for two out of the past five years before elling. Using the exemption is also only allowable once every two years.
Qualifying for the exemption is important though, as capital gains taxes can take a large piece of your profit. Short term gains on ownership less than one year, can be taxed at up to 37% and long term gains up to 20% depending on your filing status and income.
It is also important to keep in mind that widowed spouses have an opportunity to claim the larger $500,000 exemption. If a widowed spouse sells a home within two years of the death of a spouse, hasn’t remarried at the time of sale, neither the seller or late spouse took the exclusion within two years before the date of sale, and met the two year ownership and residency requirements, he/she can qualify for the larger exemption.
Widowed spouses should also be aware of stepped-up basis when calculating their gains. Most states are community property states, including New York, North Carolina, and Florida, meaning that you receive stepped up basis on half of your home value when your spouse passes. In non-community property tax states, including Arizona, California, and Texas the surviving spouse receives a full step up in basis on the entire value of the home. If you are having a tough time estimating the value of the home at the time of death, the IRS will accept a report from a qualified appraiser who can do a retrospective appraisal which determines the fair market value at a specific date in the past.
Most of us don’t buy and sell homes that frequently, but keeping these rules in mind can help when making decisions about selling your family home. A big tax bill and the potential for a new mortgage at higher interest rates may have some thinking twice before moving.
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