Whether you’re moving into a larger home for your growing family or relocating for your career, this is a common question. No matter your reason for moving, it’s important to understand the tax implications of selling your house so you know what to expect and how to plan. Find out how potential capital gains taxes may be reduced or eliminated with the Section 121 Exclusion.
See the transcript below the video if you prefer to read!
I’m often asked how taxes work after selling your home. If you’re like many young families in your 30s and 40s, you may be selling your home for the first time. Maybe you need more space for your growing family, or maybe you want to move closer to extended family. Whatever the reason, this is a great question.
Understanding Capital Gains And Cost Basis When Selling Your House
Essentially, if you sell your home for more than what you paid, taxes could potentially be owed on that gain. Let’s start with a basic example. Let’s say you originally purchased your home for $350,000 and you just sold your home for $450,000. That difference of $100,000 is a capital gain and taxes could potentially be owed on it.
The $350,000 purchase price is your cost basis. The cost basis can be adjusted for things like renovations, major improvements, and even some closing costs. The cost basis can’t be adjusted for things like repairs and general upkeep though. For the sake of simplicity, we’ll ignore these adjustments in our example.
Note that you can also subtract some selling expenses from your home’s sale price, but rather than adding too much complexity, we’ll assume zero to keep the example simple.
Potentially Reducing Or Eliminating The Capital Gain
So let’s figure out if taxes are owed on the $100,000 gain. There’s an exclusion that may apply, and it can reduce or eliminate the gain that taxes could be owed on. It’s called the Section 121 Exclusion, and if it applies, it can exclude $250,000 from the gain (or $500,000 if you file married filing jointly).
It usually applies if you meet two tests, the residence test and the ownership test. Basically, if you owned your home and lived in it for two of the last five years, the exclusion most likely applies. But if you’ve already used the exclusion on another home within the last two years from the date you sold your current home, you cannot use it again within such a short time frame.
And of course, with tax law, there are nuances and special cases. I won’t get into those here, but know they exist and could impact how the exclusion applies to you.
Will Capital Gains Taxes Be Owed?
Back to our example, if the exclusion applies, that $100,000 gain will not be taxed. Now, if the exclusion does not apply or does not cover the entire gain, capital gains rates will apply either short-term or long-term, depending on how long you owned your home. And another note. If there’s a loss, you cannot deduct it. Unfortunately, the IRS only cares about gains when you’re selling your house.
