By Jane Young
As Baby Boomers near retirement many are thinking about downsizing to a new home, moving to live closer to grandchildren or to get away from the cold winters. Regardless of the reason for selling your home, a common question is how much capital gains tax will be due on the sale. Thankfully, there is a large exception on capital gains due to the sale of a personal residence so most people will owe little to no capital gains taxes on the sale of their home.
The IRS Section 121 exclusion allows individuals to exclude up to $250,000 and married couples to exclude up to $500,000 in capital gains on the sale of their personal residence if certain conditions are met. You must own the home for at least two years and live in the home as your principal residence for two of the last five years, prior to the date of sale. The two years do not have to be consecutive. Generally, you are not eligible if you excluded the gain from the sale of another home during the two-year period prior to the sale.
There are exceptions to the ownership and residency requirements for those who are in the uniformed services, the foreign service, or the intelligence community. There are also exceptions to allow for “unforeseen circumstances” such as an illness, job loss, divorce, or a natural disaster. Refer to IRS Publication 523 at IRS.gov for more information about exceptions to the requirements.
Under current law, you cannot roll the full value from the sale of your home into the purchase of a new home to avoid capital gains.
If you anticipate the capital gain will be more than the Section 121 exclusion, you can calculate your capital gain by determining your cost basis. The capital gain, or loss, is the sales price of your home less your cost basis. The cost basis is the purchase price plus closing costs, settlement costs (not including escrow for taxes and insurance), and commissions. Your cost basis also includes capital improvements, renovations, and landscaping. However, it does not include repairs.
A complete list of the allowable expenses is available in IRS Publication 523. If you anticipate owing capital gains taxes, keep receipts for all capital improvements to maximize your cost basis.
Generally, investment property or vacation property do not qualify for an exclusion unless you lived in the property for two of the last five years. If you have taken depreciation on your home, you must pay depreciation tax as part of the sale even if you do not owe capital gains tax, unless you do a 1031 exchange.There is no capital gain tax due on a home that is inherited. When the homeowner dies the heirs receive a step-up in cost basis. An heir’s cost basis becomes the value of the home on the date of the homeowner’s death.