It’s no secret that the housing market in many parts of California and the rest of the country has favored sellers. That means after sitting tight through the housing market crash, many people who sold their homes this year brought in a nice little profit.
But could that profit lead to capital gains taxes when it’s time to file income tax returns? It depends on what the sellers’ “gains” were on the sale as well as several other conditions.
The first thing you need to know is that according to the law that applies to homes sold after May 6, 1997, up to $250,000 in capital gains from the sale of a home can be excluded from taxes. The amount doubles $500,000 for homeowners who are married.
Calculating your gain
However, it’s important to point out that the capital gain isn’t necessarily the profit that the homeowner makes on the sale. In other words, if you bought your house for $300,000 and sold it for $500,000, that doesn’t necessarily mean that your capital gain is $200,000. There is a lot more to the calculation than that.
In order to find the gain, you take the selling price and subtract any deductible closing costs and selling costs. Then you subtract the tax basis in the property. In order to figure out the tax basis, you take the original purchase price of the home, add purchase expenses and the cost of capital improvements, and subtract any depreciation and/or casualty losses or insurance payments.
Other conditions that apply
The Ownership and Use Test: In order to exclude the full $250,000 gain (or $500,000 gain) the property must have been the homeowner’s primary residence for at least two of the five years leading up to the sale.
Exceptions to the Ownership and Use Test: The homeowner may still be entitled to claim part of the deduction without meeting the test if the home sale is due to: employment changes, health reasons confirmed by the homeowner’s doctor, divorce or an unforeseen circumstances such as death or multiple births.
Homeowners who move to nursing homes: A special rule applies to homeowners who move to nursing homes before living for two years in the home they sold. The rule requires the homeowner to have lived in the home for just one out of the five preceding years.
More information on capital gains taxes following the sale of a home can be found in IRS Publication 551, Basis of Assets, under the real property section.