Tax Treatment for the Sale of Homes
The U.S. tax code treats selling a house very favorably. Unless a homeowner has racked up super-sized gains on his house or hasn't lived there long enough, capital gains taxes can usually be avoided altogether.
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Capital Gains Rules
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The basic rule of thumb for homeowners selling their house is that there are no capital gains taxes to be paid as long as they've lived there primarily at least 2 years out of the past 5 years and haven't made a profit of more than $250,000. Married couples can make a profit of up to $500,000 before capital gains taxes are assessed. Profits above $250,000/$500,000 are taxed at normal capital gains rates. Losses on the home cannot be used to offset capital gains or ordinary income.
Investment Properties
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The rules work differently for investment properties than for primary residences. Gains on investment properties are taxed at regular capital gains rates just like stocks. But people can get around this by making the investment property their primary residence for at least 2 years out of the 5 years preceding the sale. The 2 years of living there don't have to be consecutive. Homeowners can take advantage of the tax exclusion once every 2 years.
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Cost Basis
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Cost basis must be calculated before a homeowner can determine how much of a profit she has made on the sale. Any capital improvements to the property can be added to the price paid to figure out the basis; for example, a person who bought a $250,000 home and then did a $50,000 renovation would have a basis of $300,000 for tax purposes. The seller can then subtract costs incurred during the sale (for example, Realtor commissions) from the sales price. A homeowner who sold her house for $600,000 and paid $50,000 to sell it would have zero capital gains taxes ($550,000 sales basis minus $300,000 cost basis = $250,000 gain.
Special Cases
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There are a few special cases that people need to know. Military personnel who are transferred before they have lived in the house for 2 years are exempted from the rule. Time spent in a nursing home counts toward the 2-year residency requirement. Married couples filing jointly must have both lived in the house for at least 2 years, but they don't have to have been married the whole time. It's also okay if either the husband or wife owned the house on his or her own before the marriage.
Partial Credit
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People who have to sell their home before living there 2 years because of an unforeseen change in their life (such as a health problem or a job transfer) can qualify for a partial credit that's based on the amount of time they've been there. For example, a homeowner who has been in the house for 1 year before being forced to sell because of a job transfer doesn't have to pay taxes on the first $125,000 of profits on the house ($250,000 if married). That is because the time he lived there (12 months) is half of the 24-month requirement, so he gets half the tax benefit.
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