Capital gains tax is what you pay on the profit you make from the sale of an investment. Sale price – purchase price = capital gain. It’s as easy as that.
If you’re under the limit of $500,000 in profit for married couples and $250,000 for singles, you’re in the clear. That’s right—no taxes on the profit you make from selling your home.
Pre-1997, things weren’t nearly as rosy for sellers who made a profit on their homes. The only way you could avoid paying taxes on your profit was to buy another, more expensive home within two years of selling your old home. You also had to fill out a form to prove that you were exempt.
The Taxpayer Relief Act of 1997 changed all that, making it easier for people to sell their homes without having to buy new ones. Now, you can use the profit you make on anything you want, and you don’t have to report anything to the IRS if you’re under the limit.
The truth is that most homeowners won’t owe a penny to the IRS over the sale of their home, but there are a few circumstances that will mean you have to pay. So let’s get down to business and go over some of the rules of the law.
First, the home in question must be your primary residence. You must live in this principal residence for at least two of the previous five years before you sell it.
This means every sale has to be at least two years apart, but you can sell without paying taxes again and again and again.
If you’re married, it means you are safe from $500,000 in profit from your home’s sale. However, there are a few rules:
Either spouse can meet the ownership test. If you’ve owned your home for the past two years but just added a spouse to the title after getting married a year ago, you meet the ownership test even though your spouse wasn’t an official owner for the full two years.
Both spouse have to meet the use test; they both must live at the residence for two years. If you shared the home for a year before marriage and a year after marriage, you meet the requirement.
If you don’t pass one of these tests, only your single $250,000 waiver will apply.
Also, if either spouse used the exemption in the past two years, the couple cannot use it until the two years has passed.
To arrive at your gain amount, you must establish what’s called your basis in your home.
Your basis in the home is what you paid for the home plus capital improvements you’ve made. These are things that add market value to a home—here’s a helpful list of eligible improvements.
(Important note: if you sold a home before the law change in 1997 and rolled that profit into a home you’re selling now, you must take that amount out of your basis now.)
Next you subtract your basis from what you got from the sale. Take commissions and other selling expenses out of your proceeds from the sale. For example:
Original Sales Price: $300,000
Capital Improvements: $10,000
Basis in Home: $310,000
$500,000 sale price – $30,000 commission – $310,000 basis in home = $160,000 profit
If you must sell before two years because of special circumstances, including employment change, health, or other unforeseen circumstances, you may be eligible for a prorated, tax-free gain.
In cases like these, you’ll calculate the amount of time you met the two-year use test. If you’re transferred to another city after being in the home for just a year, you divide 12/24 and get 0.50. Multiply the married exclusion amount by .50, and you’ll be eligible to exclude up to $250,000 in profit.
A law change in 2003 exempted military personnel from the two-year use requirement, letting them sell tax-free whenever they have to move for the military, something that happens all the time.
Please keep in mind that I’m a loan officer and not a tax professional. This blog post is for informational purposes only and does not constitute legal tax advice. For that, talk with your accountant!
“I had the best experience with CSMC Mortgage. Buying a home is very stressful with all of the paperwork that has to be filled out. Faye was amazing! I have given several people her contact info, who are scared to take the step to homeownership. She took ALL of the stress away for me. I honestly, didn’t have to do much. She accommodated my crazy work schedule and help me get things done in a timely manner. She made me feel so comfortable and at ease. There were no surprises when it was time to sign and pay. I highly recommend her to anyone in need of her services and guidance. I can’t thank her enough.”
- Lisa M.
“David Honda and his team rocked!! They had great technology that took so much of the pain of home buying away. They were attentive to our specific needs and were on top of our loan process! David was always available, even when he was in Hawaii, and super responsive! Thanks David, Melissa and the team for an easy and great home buying experience.”
- Raymond F.
“These folks are conscience and easy to work with. The “calm” as the “storm” of home loans rolls through! I would not use anyone else. They make sure ALL your questions are answered, be that what competitors may have offered, or ads you may have heard or seen. What a pleasure to do business with. Thank you team CSMC.”
- Michael G.
“With this being my first home purchase, my loan officer was very good at explaining everything to me and helping me with all my needs. Thank you for having such great people in the right place!”
- Cathleen H.
“Faye helped me purchase my first home last year. She was very professional and worked very quickly to help me procure financing. She made herself available around my schedule and took the time to explain my options for financing to help me get the lowest rate possible. Would highly recommend her to anyone looking for someone that is professional, highly knowledgeable, polite, and responsive.”
- James Z.
“CSMC Mortgage took great care of us and our home buying needs. Tony was more than we could have ever asked for, he went above and beyond for us and we couldn’t have been more grateful for all his hard work. CSMC Mortgage has a great and friendly staff, I would highly recommend them to anyone looking into buying a home.”
- Jannet A.
“Baret Grigorian was amazing!! From start to finish Baret was there to help in every way. I never felt like I had to call him to follow up on my loan transaction and he always kept me informed. He was able to get me great financing rates, a lower payment AND money back! Thank you Baret!! I look forward to working with you again in the future!!”
- Kenny D.
“This review is about Mark and Darci Richardson from CSMC Mortage in Simi Valley. This team is the BEST! For the past 12 years our home was "underwater" due to the "crash" in 2007, and unable to do anything with the mortgage except pay it. These two kept on top of things and finally the house qualified to REFI. We just completed everything and it closed last week... and they saved us over $900 a month!! That's a huge savings for a couple of senior citizens! We are SO happy now and finally can breathe. Thanks to Mark and Darci and CSMC Mortgage for following through, jumping through all the hoops necessary and helping us out! I can't recommend them more... they are the BEST!!!”
- Shari S.