The short answer is maybe. Sellers have been jumping for joy over the fast increase in prices over the past 3 years. Most people don’t know their personal home is considered a capital asset, subject to capital gains tax. If your home has appreciated in value, you could be required to pay taxes on the profit.
The Taxpayer Relief Act of 1997 helped reduce some of the tax burden. If you are single, you will pay no capital gains tax on the first $250,000 of profit and married couples get a $500,000 exemption.
There are, however, some restrictions.
1) This exemption is only allowable once every two years.
2) You can add your cost basis and costs of any improvements that you made to the home to the $250,000 if single or $500,000 if married filing jointly. Yes, keep ALL the receipts for everything spent on the home.
3) This even applies if you have rented the home out as long as you have lived in the house for at least two years. The two-year residency requirement does not need to be fulfilled in consecutive years.
4) Remember if you hold a property for less than a year the gain is taxed at ordinary income. Ouch!
The 2-in-5-Year Rule
For taxpayers with more than one home, a key point is determining which is the primary residence. The IRS allows the exclusion on only one’s primary residence, but there is some leeway in just which home qualifies. The two-in-five-year rule comes into play. Simply put, this means that during the previous five years, if you lived in a home for a total of two years or 730 days, that can qualify as your primary residence. The 24 months do not have to be in a particular block of time. However, for married taxpayers filing jointly, each spouse must meet the rule.
How the Capital Gains Tax Works With Homes
Suppose you purchase a new condo for $300,000. You live in it for the first year, rent the home for the next three years, and when the tenants move out, you move in for another year. After five years, you sell the condo for $450,000. No capital gains tax is due because the profit ($450,000 – $300,000 = $150,000) does not exceed the exclusion amount. Consider an alternative ending if the home values in your area have increased exponentially.
Let’s say you sell the condo for $600,000. Capital gains tax is due on $50,000 ($300,000 profit – $250,000 IRS exclusion). If your income falls in the $40,400–$441,450 range, your capital gains tax rate as a single person is 15% in 2021. (The income range rises slightly, to the $41,675–$459,750 range, for 2022.) If you have capital losses elsewhere, you can offset the capital gains from the sale of the house with those losses, and up to $3,000 of those losses from other taxable income.
Consult a Tax Professional
Before you sell your home talk to a tax professional, so you won’t be surprised by an unexpected tax bill.