A net gain of $590,000 on the sale of a home will ensure that at least some of the money is potentially taxed, regardless of your circumstances. But in many cases you don’t have to pay tax on that entire amount.
A home seller can normally exclude a gain of up to $500,000 from federal taxes on the sale of their primary home. However, this only applies to a married couple who file a joint tax return. An individual filer can exclude up to $250,000. But an exclusion may not be available if the seller has not lived in the home for at least two of the previous five years, or has previously taken advantage of the exclusion up to those lifetime limits.
Other details may also affect your applicable taxes on the net amount of $590,000. Additionally, several strategies exist that can sometimes reduce or eliminate taxes on the sale of a home when downsizing. While we review the overarching rules below, the nuances of your specific situation can be clarified by a consultation with a financial advisor.
When you sell an asset for more than you paid for it, the IRS considers the amount of the gain to be a taxable capital gain. This applies to the sale of any type of asset, including stocks, bonds and investment properties. However, when selling a personal home, some or all of the gain may be excluded from tax. The excluded amount can be up to $500,000 for a married couple, or $250,000 for a single filer.
However, this exclusion is not always possible. This is only allowed if the seller has lived in the home as his main residence for at least two years in the past five years. If the seller has lived in the home for less than a cumulative two years in the past five years, the entire gain is taxable. And it’s only for a primary residence. Holiday homes, second homes and investment properties are not eligible. Finally, the exclusion applies for your entire life. So if you previously used the exclusion on another home sale, that use will be deducted from your available remaining exclusion.
The applicable tax rate also depends on the specific circumstances. For example, if the seller has owned the home for less than a year, any taxable gain is considered a short-term capital gain. This type of gain receives the same treatment as ordinary income, and the tax is calculated based on regular federal income tax brackets. These rise to a top marginal rate of 37%.
On the other hand, if the seller has owned the home for at least one year, a different tax table system applies. These are the long-term capital gains tax tables, and they are much lower than the tables used for ordinary income. Depending on the seller’s income, the capital gain percentage can vary from zero to a maximum of 15%.
A married couple who earned $590,000 from a move to prepare for retirement would not be able to exclude any of the gain if they had lived in the home for less than two years in the previous five years. This means the entire $590,000 could be subject to taxes.
However, if they had lived in the home for at least two of the previous five years, they could exclude up to $500,000. That leaves a maximum of $90,000 as a taxable portion of the profit. If the seller is single, or a married individual filing alone, the exclusion is limited to $250,000. That would leave $340,000 in taxes.
The applicable tax rate depends primarily on whether the seller has owned the property for at least one year before the sale, and secondly on the seller’s income tax bracket. For example, if the seller has not owned the home for at least a year, the gain is normally taxed as ordinary income. The applicable income tax rate depends on the seller’s income. For a sale where the property was owned for more than a year, the preferential capital gains rates of 0%, 15% or 20% would apply, instead of the regular income tax rates. Your capital gains tax rate also depends on your income.
A financial advisor can help you determine whether you will owe taxes on the sale of your home, depending on your specific circumstances. Get matched with a financial advisor.
There are some other ways to manage taxes on the profits from the sale of a home. One is to apply any adjustments to the home’s cost basis. The cost of some improvements can in principle be deducted from the sales price, reducing the amount of profit. For example, if the home seller had previously spent $60,000 to add a room and $30,000 to replace the roof, this $90,000 cost basis adjustment could reduce taxable gain for a married seller to zero.
It may also be possible to take advantage of tax loss harvesting, which involves applying a loss to the sale of another asset to reduce capital gains. For example, if the seller had sold shares at a loss of $50,000, this could be used to reduce the capital gain by that much. If that were to happen, taxable gain for the married seller could be reduced to $40,000.
A more complicated strategy, called a type of exchange, could defer, but not eliminate, capital gains taxes on profits. Also called a 1031 exchange, this approach allows a property owner to trade an investment property for a cheaper property without immediately having to pay taxes on the difference in the prices of the two properties. However, like-kind exchange can only be used for investment properties. It may be possible to make a similar exchange when downsizing, but this requires the house being sold to be rented for at least two years before the sale. Then, after the sale, the purchased home would also have to be rented out for a comparable period before it could be used as the retiree’s main residence.
For help with a capital gains strategy for selling your home and beyond, consider consulting a financial advisor.
You may be able to exclude all or part of the gain on the sale of a home if you lived in the home for two years before the sale. The allowable exclusion is $250,000 for single filers and $500,000 for married couples. If the gain exceeds the exclusion allowance, or if an exclusion is not possible, the applicable tax rate on the taxable amount depends on how long the property was owned by the seller before the sale. Up to one year, the gain is likely to be taxed as ordinary income. If it was owned for more than a year, lower long-term capital gains taxes may apply.
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SmartAsset’s Capital Gains Tax Calculator is a quick and free way to estimate how much capital gains tax might be on the sale of real estate, stocks or other assets.
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A financial advisor can help you determine what your tax liability may be when selling your home. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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