One of the best tax breaks available to homeowners is the capital gains exclusion on the sale of a primary residence. This important tax benefit is fairly simple yet often misunderstood so I thought I would provide a summary of what the average homeowner should know about.
What is the capital gains exclusion?
The tax code allows home sellers to exclude the first $250,000 for individuals ($500,000 for joint filers) from any capital gain tax liability.
How is a capital gain calculated?
Simply put, a capital gain is equal to the difference between the price a home seller paid for a home and what they sold it for. For example, a home that was bought for $300,000 and sold for $400,000 would have a $100,000 capital gain.
There are additional items which can go into this calculation such as improvements made to the property during the term of ownership, closing costs, real estate commissions, etc.
Are there any conditions which must be met to qualify for the exclusion?
Yes, a home seller must have lived in the subject property as their primary residence for at least 2 years of the previous 5 years from the date of sale. For example, if a home seller closes on their home on January 1, 2008 and realizes a $250,000 gain, they must be able to prove that they lived in the property for at least 24 months during the time-frame January 1, 2003-January 1, 2008 in order to qualify for the exclusion.
The tax code only allows tax filers to take advantage of this exclusion once every two years. For home sales after 2008, there are some additional provisions that impact homeowner’s who used a home as a primary residence AND a rental property within the 5 years of the date of sale. It is best to check with a tax professional in these instances.
Does a home seller need to “reinvest” the capital gain into a new home in order to qualify for the exclusion?
NO! This is a commonly held myth that many homeowners believe is the case. This myth is rooted in the previous tax code which allowed home sellers to exclude their capital gains from tax liability so long as the gain was reinvested into a new home. This rule was changed with the Taxpayer Relief Act of 1997. Now homeowners may do whatever they please with their gains.
Can a capital loss from the sale of a primary residence be deducted from a home seller’s taxable income?
Where can I get more information on this topic?
For complete details on this topic I would recommend downloading and reading the IRS publication 523 which deals with selling your home. You may download this document by clicking this link.
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