The prospect of earning profit from the sale of your home is exciting, but paying taxes can seem daunting. Luckily, there’s a good chance you won’t need to pay a cent to the IRS.
If you’ve lived in a popular area for some time, it’s possible your home appreciated and selling it will net you a profit. Depending on how much you earn, the IRS might take a significant chunk. It’s important to understand the costs of selling your home and how to calculate net proceeds. That way you’ll know whether to expect a big tax liability.
However, you might not have to pay anything. You could qualify for the capital gains exclusion if you’re selling your primary residence and meet certain requirements. If that’s the case, you may not need to report the sale of your home to the IRS. Here’s how to qualify and what to do if you don’t.
How do you avoid paying taxes when selling a house?
In most cases, the IRS lets you exclude up to $250,000 in real estate capital gains from your primary residence when filing your income taxes. If you’re married and filing jointly, that maximum doubles to $500,000. To qualify, you’ll need to meet these conditions:
- You are not subject to expatriate tax
- The property was not acquired through a like-kind exchange
- You or your spouse owned the home for at least 24 months out of the last five years before the sale
- Your spouse and you lived in the house for at least 24 months out of the last five years before the sale
- You haven’t claimed the capital gains exclusion on the sale of another home in the last two years
Note that if your spouse doesn’t meet the residency requirement because you were only recently married, the IRS will evaluate both of you separately to see what exclusions you are each entitled to. The IRS will assume for the purpose of the analysis that both spouses owned the home for the same amount of time.
If you profited more than the maximum exclusion amount from the sale of your home, be sure to make any necessary adjustments when figuring your capital gains. You can increase your basis by including qualifying closing costs and any capital improvements you made on the property. Painting, cleaning, and necessary repairs don’t qualify as capital improvements, but new features, systems, and appliances do.
For example, let’s say you’re single and you bought your house for $400,000. You’re about to sell it for $680,000. You spent $3,000 on closing costs, $5,000 to add a new driveway, $12,000 to install an HVAC system, and $15,000 to add new siding. Since your net gain was only $245,000, you won’t need to pay any taxes on the profits. Just make sure to keep your receipts for all the work you put into your house.
Read More: What Expenses Can You Deduct When Selling a Home?
When do you need to pay taxes when selling a house?
If any of the following are true, you won’t qualify for the capital gains exclusion:
- The house was a vacation home or rental property
- You haven’t yet owned the house for two years
- You didn’t live in the house for at least two years (exceptions are made for military service members and people with disabilities)
- In the last two years before the sale, you already claimed the capital gains exclusion
- You are subject to expatriate tax
- You acquired the home through a like-kind exchange
If you don’t meet the qualifications for the capital gains exclusion, you might still be able to get a partial exclusion of gain if you are selling your house due to a work-related relocation, a health issue, or another unexpected event such as the destruction of your home.
Related: What Taxes Do I Need to Pay When Inheriting a Home?
Reporting the sale of your home to the IRS
If your capital gains exceed the $250,000 maximum (or $500,000 for married couples filing jointly), or if you are otherwise disqualified from claiming the capital gains exclusion, you’ll need to report the sale of your home using Schedule D and Form 8949. Consult Publication 523 for details on how to report the sale on your income tax return. You’ll likely have to pay state income tax as well.
If you earn $40,000 per year in income or less (or $80,000 or less for married couples filing jointly), the capital gains tax rate is 0%. Otherwise, you’ll pay either 15% or 20% on your earnings from the sale of your home, depending on your income.
Read More: 5 Tax Tips in Times of Uncertainty
With the capital gains exclusion, it’s possible for homeowners to walk away with quite a bit of profit without worrying about the tax burden. However, the tax code is nuanced and ridden with requirements and exceptions. If you’re unsure about your tax liability, you should consult a tax preparer for advice.