Selling a Home? Important Information About Capital Gains Taxes
Capital gains taxes results whenever an investment is sold. Since a home is considered to be an investment for the homeowner, these taxes can apply. The good news, however, is that most homeowners may not owe this tax on the sale of their home as long as they meet certain requirements. If you are preparing to list your home for sale (in Orange County or elsewhere) and are concerned about capital gains taxation, the following information may provide the answers you need.
How is the Capital Gains Tax Computed?
Capital gain for the purpose of taxation when selling a home may apply anytime that the sale price exceeds the price the owner originally paid for the home. The formula used is simply the sale price minus the purchase price equals a gain in capital, or capital gain.
However, the amount of profit may be reduced by the cost of home improvements that the seller may have invested in the home. These expenses, however, must be verifiable through receipts or financial records deemed acceptable by the Internal Revenue Service.
What is the Capital Gains Tax Exclusion?
The Internal Revenue service grants an exclusion to homeowners to help protect them from having to pay capital gains taxes when selling their primary residence. At the current time, the exclusion for a single individual is for $250,000, and double that, or $500,000 for married couples.
This exclusion was broadened as part of the Taxpayer Relief Act of 1997, to replace previous, more restrictive capital gains rules. Under the old rules, the exclusion could only be used once during a lifetime. Now, however, this exclusion can be used on each home sale, with no cap on the number of times the exclusion is used. In addition, the profit from the sale of the home no longer has to be reinvested in another home in order to avoid paying capital gains taxes.
Requirements Must Still Be Met
While easing the previous exclusion limits was very good news for home sellers, some requirements must still be met in order to avoid paying capital gains taxes on a home sale. These requirement include:
- The home being sold must be the seller's primary residence and does not apply to investment properties or vacation homes.
- The seller must have owned the home for at least two years immediately preceding the date of sale.
- The seller must have lived in the home being sold for at least two of the five years immediately preceding the sale date.
Homeowners whose home sale results in profits over the exclusion limits set by the IRS will owe capital gains tax on the amount of that overage if they are in a tax bracket of 25 percent to 35 percent or higher. Sellers who are in the lower tax bracket of 10 percent to 15 percent may not owe a capital gains tax in this situation.
For more information about capital gains taxation or to get answers specific to your individual ownership situation, homeowners are advised to speak with a competent tax attorney, accountant, or tax preparer in their area. If desired, real estate professionals can assist their listing clients in finding these services.