Figuring Capital Gain
When you sell a home you’ve owned for a long time or during a period of rising home prices, you may have a capital gain. In other cases, you may have a capital loss. You calculate the gain or loss in several steps:
- You determine the sales price and then subtract the expenses of selling the property. The result is your adjusted sales price, or amount realized.
- You calculate your total basis, also called your cost basis. This includes the amount you paid for the property originally, plus fees and closing costs, as well as what you have spent on construction, renovations, improvements, or repair. The list of qualifying improvements is impressively long and includes, among other things, interior and exterior upgrades, additions, heating and plumbing systems, landscaping, and fencing. You can find the details, along with other valuable information, in IRS Publication 523, “Selling Your Home.” In some cases, the basis may need to be reduced, or adjusted, by figuring in certain tax credits, insurance settlements, or other payments.
- You then subtract the adjusted total basis from the adjusted sales price to find your capital gain or capital loss. If the transaction produced a gain, you must determine if any of that gain is taxable.
You should be aware, though, that you may have to make an adjustment to the total basis if you sold one or more homes before 1997 but none since. Prior to that date, if you reinvested in a more expensive home within two years of selling your home, there was no tax on any capital gain you realized. However, when you sell this time, you’ll have to subtract the accumulated profit on which you deferred paying taxes in determining the adjusted total basis.
You may have to make an adjustment to the total basis if you sold one or more homes before 1997 but none since.
Are Taxes Due?
The law provides a tax break on the sale of your primary residence if you’ve lived in the home for at least two of the five years before you sell and pass the other qualifying tests. Specifically, if you’re single, the first $250,000 of capital gains is excluded from tax. That number doubles to $500,000 if you’re married and filing a joint return. You may qualify for the larger exemption if your spouse has died within the two years prior to the sale.
If you used part of your home for business or rental you usually don’t qualify for the full exclusion. The same applies if you haven’t occupied your home for the required two-year period and don’t meet one of the allowable reasons for not doing so. Even in these cases, however, a portion of your gain may still qualify for tax exemption, though determining that number requires a detailed calculation.
In most cases, if you have a taxable gain that is less than the exempted amount, you don’t have to report the sale of your home on your tax return, though you may choose to do so. Other income from the sale such as the sale of personal property that will remain in the home may have to be reported, though, so you should always work with your tax advisor to ensure you’re reporting the correct amount.
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