Legal Option Title Agency, Inc.

Before Congress passed the Taxpayer Relief Act of 1997, you basically had two choices when you made money on the sale of your house.....pay significant capital gains taxes on the profits, or buy a house of greater value within two years.  Only if you were over 55 could you exclude a certain amount of profit, and then, only once in your lifetime.

Now virtually all sellers (except those at the highest end of the market) can keep any profits they make on the sale of a house with negligible tax consequences.....making homeownership a potentially lucrative long-term means.

Understanding Capital Gain

For home sellers, capital gain is the difference between what you paid for a house and what you sell it for, minus the cost of any capital improvements.  Capital improvements are home improvements that change the structure or livability of your home, such as a remodeled kitchen or room addition.  Today’s tax rules allow the following:

• Married couples or co-owners who file taxes jointly may keep $500,000.00 in profits tax-free on the sale of a home they have owned and lived in for two of the past five years.  Anything above that amount is taxed at 20 percent.
• Single homeowners may keep $250,000.00 in profits tax-free on the sale of a home they have owned and lived in for two of the past five years.  Anything above that amount is taxed at 20 percent.
• Rental property owners may defer some capital gains tax if they purchase another rental property and qualify for a 1031 exchange, but not if they buy a personal residence.

Essentially, you are free to sell a residence every two years and pocket the profits.

If you own and occupy your house for less than two years before you sell, you can still qualify for a prorated exclusion from capital gains tax if you are selling because of a job transfer or health problems.  The IRS and Congress however, are continually refining these rules.  It is best to check with your tax advisor.

Calculating Improvements

Not every home improvement constitutes a capital improvement.  Replacing the roof is an improvement, but it does not add value to your home.  But adding a bathroom or remodeling two bedrooms into a master suite does.  Keep track of your improvements:

• Start a file immediately after you buy a home
• Include your closing papers and appraisal records
• Save all documents relating to any home improvements, separating capital improvements from regular maintenance and repairs

Even if you don’t expect to pay capital gains tax, you may need the paperwork to document your asking price when you sell your home.

If You Sell for Less

If you need to sell your house for less than what you paid for it, you cannot claim a capital loss (as you can when you sell other investments at a loss).  You also could be hit with extra income taxes if your lender agrees to forgive any remaining mortgage debt after you sell.  Congress has targeted this tax law for change, so consult your tax advisor if you are in this situation.

No Help for Home Offices

Working from home can have tax consequences when you sell.  If you have been deducting your home office from your federal income taxes, when you sell your home you’ll have to pay taxes on that portion of your profits equal to any depreciation on the office you have claimed previously.  If you stop using your office space for a year or two before you sell, you could escape the tax bite.  Consult your tax advisor.