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For home sellers, capital gain is the difference between what you
paid for a house and what you sell it for, minus the cost of any
capital improvements. Capital improvements are home improvements
that change the structure or livability of your home, such as an
added room or remodeled kitchen. Today's tax rules allow the following:
- Married couples or co-owners who file taxes jointly
may keep $500,000 in profits tax-free on the sale of a home they
have owned and lived in for two of the past five years. Anything
above that amount is taxed at 20 percent.
- Single homeowners may keep $250,000 in profits
tax-free on the sale of a home they have owned and lived in for
two of the past five years. Anything above that amount is taxed
at 20 percent.
- Rental property owners may defer some capital gains
tax if they purchase another rental property and qualify for a
1031 exchange, but not if they buy a personal residence.
Essentially, you are free to sell a residence every
two years and pocket the profits.
If you own and occupy your house for less than two
years before you sell, you can still qualify for a prorated exclusion
from capital gains tax if you are selling because of a job transfer
or health problems. The IRS and Congress are continually refining
these rules, however. It is best to check with your tax adviser.
The time-limit requirement is looser for members of the military,
Foreign Service and other government agency personnel on overseas
assignments, and for private industry employees sent overseas by
their companies. For more information, consult your tax advisor.
Not every home improvement constitutes a capital improvement. Replacing
the roof is an improvement, but it does not add value to your home.
But adding a bathroom or remodeling two bedrooms into a master suite
does. Keep track of your improvements: Start a file immediately
after you buy a home. Include your closing papers and appraisal
records. Save all documents relating to any home improvements, separating
capital improvements from regular maintenance and repairs. Even
if you don't expect to pay capital gains tax, you may need the paperwork
to document your asking price when you sell your home.
If you are forced to sell your house for less than what you paid
for it, you cannot claim a capital loss (as you can when you sell
other investments at a loss). You also could be hit with extra income
taxes if your lender agrees to forgive any remaining mortgage debt
after you sell. Congress has targeted this tax law for change, so
consult your tax advisor if you are in this situation.
Working from home can have tax consequences when you sell. If you
have been deducting your home office from your federal income taxes,
when you sell your home you'll have to pay taxes on that portion
of your profits equal to any depreciation on the office you have
claimed previously. If you cease using your office space for a year
or two before you sell, you could escape the tax bite. Consult your
tax advisor.
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