Understanding the Tax Implications of Selling Your Primary Home

Whether you're considering selling your home now or in the future, understanding the tax implications of this significant financial decision is crucial. The sale of your primary residence can have various tax consequences, and being informed can help you make the best choices for your financial well-being. This newsletter aims to provide you with valuable insights into the tax aspects of selling your home, ensuring you are prepared and confident in your decisions.

The Basics of Capital Gains Tax

When you sell your primary residence, you may be subject to capital gains tax on the profit from the sale. The capital gain is calculated as the difference between the selling price of the home and its purchase price (plus any improvements made over the years). However, the tax code provides some relief for homeowners through the primary residence exclusion.

Primary Residence Exclusion

The primary residence exclusion allows homeowners to exclude up to $250,000 of capital gains from their income if they are single, or up to $500,000 if they are married and file jointly. To qualify for this exclusion, you must meet the following criteria:

1. Ownership Test: You must have owned the home for at least two of the five years preceding the sale.
2. Use Test: The home must have been your primary residence for at least two of the five years preceding the sale.
3. Frequency: You can only claim this exclusion once every two years.

Calculating Capital Gains

To determine your capital gains, subtract your home’s adjusted basis from the sales price. The adjusted basis includes the original purchase price plus the cost of any improvements made to the property as well as closing costs. For example:

• Original Purchase Price: $300,000
• Home Improvements: $50,000
• Closing Costs: $15,000
• Adjusted Basis: $365,000
• Selling Price: $615,000
• Capital Gain: $615,000 - $365,000 = $250,000

In this scenario, if you are single, you could exclude the entire $250,000 capital gain from your taxable income, owing no capital gains tax.

Reporting the Sale

If you qualify for the primary residence exclusion and your gain is below the exclusion limit, you typically do not need to report the sale on your federal tax return. However, if your gain exceeds the exclusion limit or you do not qualify for the exclusion, you must report the sale on Form 8949 and Schedule D of your tax return.

Planning Ahead

Effective tax planning can help you maximize the benefits of selling your primary residence. Here are a few strategies to consider:

1. Timing the Sale: Plan the sale of your home to maximize the primary residence exclusion. If possible, wait until you meet the ownership and use tests to qualify for the full exclusion.
2. Documenting Improvements: Keep detailed records of all home improvements, as these can increase your adjusted basis and reduce your capital gains. This is specifically important for those who believe they will be above the $250k/ $500k exclusion threshold.
3. Consulting Professionals: Work with a financial planner and tax advisor to understand your specific situation and develop a strategy that aligns with your financial goals.

Special Considerations

While the primary residence exclusion is generous, there are several special considerations to keep in mind:

1. Partial Exclusion: If you don’t meet the two-year requirements due to unforeseen circumstances such as a job change, health issues, or other unforeseen circumstances, you may still qualify for a partial exclusion.
2. Home Office Deductions: If you have used part of your home for business purposes and claimed depreciation, that portion of the home may be subject to depreciation recapture, which is taxed at a higher rate.
3. Second Homes and Rentals: The primary residence exclusion does not apply to second homes or rental properties. However, if you converted a rental property to your primary residence, you might be able to exclude some of the gain.
4. State Taxes: In addition to federal capital gains tax, you may also owe state taxes on the sale of your home. State tax laws vary, so it’s important to consult with a tax professional familiar with your state’s regulations.

Conclusion

Selling your primary residence is a significant financial decision with important tax implications. By understanding the rules and planning ahead, you can make informed decisions that protect your financial interests. If you have any questions or need assistance with your financial planning, please do not hesitate to contact us. We are here to help you navigate the complexities of the tax code and achieve your financial goals.

Thank you for reading,
The Canty Financial Team

Bill Canty, CFP®, CPA, Financial Planner

Ed Canty, CFP®, Financial Planner

Joe Canty, CFP®, Financial Planner

Tina Alteri, CPA, Tax Advisor

Maureen Walsh, EA, Tax Advisor