Thursday, December 10, 2020 / by Vanessa Saunders
By Vanessa Saunders, MBA, MIMC , Broker Owner, Global Property Systems Real Estate.
In this seller’s market, we’ve seen a lot of happy people sitting at the real estate closing table admiring the profit they’ve made selling their Hudson Valley home. For some, it’s a windfall of unexpected proportions. For others...ehhh, not so much. This is because some home sellers will have to share part of their profit with Uncle Sam. It’s called Capital Gains Taxes.
The IRS and many states including New York assess capital gains taxes on the difference between what you paid for an asset — in tax terminology your “basis” — and what you sell it for. Capital gains taxes can apply to investments such as stocks or bonds, and tangible assets like cars, boats as well as real estate.
For example, if you bought a home say, 5 years ago for $200,000 and sold it today for $800,000, you’d make $600,000. If you’re married and filing jointly, $500,000 of that gain might not be subject to the capital gains tax (but $100,000 of the gain could be). If that’s you, DON’T PANIC! There may be a way out.
The IRS allows you to exclude up to $250,000 on capital gains if you’re single, and $500,000 if you are married and filing jointly. You’re off the hook for at least those amounts. But if any of the following are true for you, that exclusion is not allowed:
If you owned the property for less than two years during the five years before you sold it.
If the house wasn’t your principal residence.
If you didn’t live in the house for at least two years (not necessarily consecutively) during the last five years before you sold it.
If you’ve already claimed the exclusion on another home in the two year period before you sold the house.
If you bought the house through a Like-Kind exchange (trading your house for a similar property.
If you are subject to Expatriate Tax.
So how can you avoid capital gains taxes? Here are a few options:
Make sure you live in the house for at least two years.
If you sell a house that doesn’t qualify as a primary residence, your profits could be taxable. Flippers beware! Selling in less than one year kicks in short term capital gains which come at a higher rate than long term gains taxes.
See if you qualify for an exception.
The IRS is a generous institution and recognizes that certain situations call for mercy. If you had to sell a house because of work, health or an “Unforeseeable event” in your life, you may get a break in capital gains. Check out IRS Publication 523 for more information.
Keep track of your expenses.
You will be taxed on your profit minus what’s called the “Cost Basis” of your home - what you paid for the house, plus what you spent over the years on improvements, fees and costs such as commissions you paid a Realtor, or other costs to buy it, to expand it, to upgrade or to remodel the home. These expenses are excluded from your gains and may reduce your profit enough to get you excluded from Capital Gains taxes.
Having a sudden windfall from selling your house is admittedly a nice problem to have. Being able to keep as much of it as possible is even better.
This blog is intended as a brief overview of Capital Gains Tax law and is not intended to serve as specific advice or professional consultation. If you may be subject to Capital Gains Taxes from selling your home or other qualifying property, contact a tax consultant for professional advice.