By Elizabeth Carlassare.
Today’s topic is how to sell your house tax free.
If you’re a homeowner or plan to be one someday, this episode is for you. There’s a significant tax benefit for homeowners that’s really important to know about.
How to Sell Your House Tax-Free
If you’ve owned and lived in your house for two of the previous five years, there’s a gift for you in the Federal tax code. And here it is: the IRS allows a capital gains exclusion of up to $500,000 from the sale of your house if you’re married and file jointly. If you’re single, the exclusion is up to $250,000. And, if you’re not married, but co-own and co-habitate your house with someone else, you may each exclude up to $250,000 from the sale of the home.
This means that so long as the profit when you sell is less than these amounts, you pay no capital gains tax. It’s a great tax break!
It hasn’t always been this way. Before the Taxpayer Relief Act of 1997, you could avoid paying tax on the gain from selling your home if you used the money to buy a pricier house within the next two years. You were also allowed a one-time exclusion of up to $125,000 if you were age 55 and older. These rules are no longer the case today. These days, you can sell your home, pay no tax on the gain, and do whatever you want with the profit.
How to Take Advantage of the Capital Gains Exclusion
Let’s say, for example, you’re single and bought your own townhouse five years ago for $200,000 and put 10% or $20,000 down. And let’s say, it appreciated an average of 7% per year during that time, making your townhouse today worth a little over $280,000. If you decided to sell it at that price, your gain would be the sales price minus your selling expenses minus your cost basis.
For the sake of this example, let’s assume your cost basis is the same as your original $200,000 purchase price. So if your selling expenses including realtor commissions amounted to $17,000, your capital gain would be $280,000 minus $17,000 minus $200,000, or $63,000.
And with the capital gains exclusion of up to $250,000 for single people, you wouldn’t have to pay any tax on that $63,000 gain. Pretty neat! (And remember, that $63,000 gain came from a $20,000 down payment.) You could put your profit to many good uses, including using it to buy another home.
Renting Your Home and the Capital Gains Exclusion
The rule that you must have owned and lived in the house for two of the previous five years to take the exclusion gives you a lot of flexibility. The two years that you need to live in the home don’t have to be consecutive. They can be, but they don’t have to be. For example, you could live in the house for a year, rent it out for three years, live in it for another year, and then decide to sell it and take the exclusion. You could also own and live in the house for two consecutive years and then sell it and take the exclusion. You don’t even have to live in the house at the time you sell it, so long as you’ve lived in it two of the previous five years.
What Else Qualifies for the Capital Gains Exclusion?
If you’ve owned and lived in your home for less than two years before selling it, you may still be able to claim a prorated exclusion if you sold it because of relocating for a new job, for health reasons, or due to unforeseen circumstances.
And what if you own and personally use two homes? Can the exclusion apply to both? The capital gains exclusion applies only to your primary home, but there’s no limit to the number of times you may use the exclusion. However, you may use it no more than once every two years.
So if you want to sell your vacation or second home, you could move into it and, after living there for two years, sell it and take advantage of the tax break. Next week, I'll spend some more time on taking advantage of the capital gains exclusion if you want to sell a rental home.
As always, it’s a smart idea to consult a tax or financial advisor when making important decisions such as selling your home.
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o IRS Publication 523, “Selling Your Home”
o Tax Payer Relief Act of 1997