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Selling a home is a major life change. As you concentrate on buying a new house, you’ll need to figure out how to properly report any profits related to the sale of your house. These profits are known as capital gains, and they have the potential to significantly impact your financial plan, as selling your home may bring a large windfall of cash and extra taxes. These are the critical factors to consider when selling a house, including tax breaks, reduced exclusions, reporting requirements for your tax return and how to determine the total profit of your home sale.
It may be helpful to talk to a financial advisor to help minimize your tax liability before you sell your house.
What Are Capital Gains Taxes?
Capital gains taxes can apply when you sell a house for more than your adjusted tax basis in the property. A home is generally considered a capital asset, and your gain is typically calculated by subtracting your adjusted basis and certain selling expenses from the amount you receive in the sale. Your adjusted basis usually starts with what you paid for the home and can increase with qualifying capital improvements.
For example, suppose you bought a home for $300,000 and later spent $50,000 on qualifying improvements, giving you an adjusted basis of $350,000. If you eventually sell the property for $600,000 and have $30,000 in qualifying selling expenses, your preliminary gain would be $220,000. The amount that is actually taxable can be lower if you qualify for the federal home sale exclusion.
Homeowners who meet the IRS ownership and use requirements may generally exclude up to $250,000 of gain from the sale of a primary residence, or up to $500,000 for many married couples filing jointly. In general, you must have owned and used the property as your main home for at least two of the five years before the sale, although additional requirements and exceptions can apply.
There are two types of capital gains, which are:
- Long-term capital gains: Long-term capital gains occur when you sell an asset held for more than one calendar year. While tax rates vary, long-term capital gains are typically taxed at lower rates than short-term capital gains. The long-term capital gains tax rate varies between 0%, 15% and 20%.
- Short-term capital gains: Short-term capital gains occur upon the sale of an asset held for under a year. They are taxed as normal income, which can be a much higher rate. Income tax rates range from 12% to 37%.
Do You Have to Pay Taxes on the Sale of a House?
When you sell your house for more than you paid for it, you may have to pay capital gains tax. However, there are some situations where you may pay very little in taxes, or even nothing at all.
If you are single and you lived in your house for two of the five years directly before the sale, the first $250,000 of any profit you make on the home is tax-free. This tax-free amount increases to $500,000 if you’re married, and you and your spouse file a joint tax return.
It’s important to note that these figures refer to profit, not income. This means that the tax is based on the net amount after expenses that you gain from selling your house. It does not mean the total amount you make from selling your house but rather the difference between the original purchase price and the sale price.
Therefore, if you sell your home for less than $250,000 above your buying price, and you’ve lived in your house for at least two of the previous five years, you can avoid paying taxes on the sale of your home.
How to Determine the Profit of Your Home Sale
In order to determine if you’ll owe taxes on the sale of your home, you must calculate the profit you’ve made from selling your home. This calculation isn’t as simple as subtracting the price you paid from your sale price, though.
- First, you’ll need to figure out the cost basis for your home. Consider not only the total amount you spent to purchase the house but also how much you’ve spent on any additions or home improvements. For example, if your original purchase price was $200,000 and you spent $20,000 on adding an extra room, you will add $20,000 to your cost basis.
- Take how much you sold your home for and subtract any fees you paid, such as closing costs and realtor fees, from that amount. If you sold your home for $300,000 but paid $10,000 in fees, the total amount you earned on the sale of your home is $290,000.
- Subtract your cost basis from the total amount of money you earned from the sale. In this case, that’s $290,000 minus $220,000, resulting in a profit of $70,000.
Since that amount is less than $250,000, you won’t owe any taxes on this home sale.
How to Qualify for Home Sale Tax Breaks
There are certain tax breaks you could earn from selling your home, but first, you must meet three basic requirements.
- Home ownership: You must have owned the home you are selling for at least two years. If you’ve owned the home for less time, you do not qualify for the tax break.
- Home use: You must have used the home as your primary residence for at least two of the past five years. This means that second homes, such as vacation homes and pure rental properties, will likely not qualify for this tax break.
- Prior use: You must not have used this tax break for the sale of another home within the past two years. This means that if you are trying to sell multiple properties, the tax break can only apply to one of your properties.
If you meet these qualifications, you may be eligible for a tax break, which can be a crucial benefit when selling your home for a profit.
Qualifying for a Reduced Home Sale Exclusion
Homeowners who sell before meeting the full two-year ownership and use requirements may still qualify for a reduced home sale exclusion. The IRS generally allows a partial exclusion when the primary reason for the sale is a change in workplace location, a health issue or certain unforeseen circumstances.
A work-related move can qualify when a new job location is at least 50 miles farther from the home than the seller’s previous workplace, or when someone without a previous work location begins a job at least 50 miles from the home. Health-related reasons can include moving to obtain or provide medical care, while qualifying unforeseen circumstances can include death, divorce or legal separation, multiple births from the same pregnancy, unemployment, certain employment changes, or the home being destroyed or condemned.
The amount of the reduced exclusion is generally prorated based on how close the homeowner came to satisfying the normal two-year requirement. The IRS compares the homeowner’s period of residence, period of ownership and, when applicable, the time since they last claimed a home sale exclusion, using the shortest period and dividing it by 24 months or 730 days. That percentage is then multiplied by the normal $250,000 exclusion limit, with separate calculations generally used for spouses filing jointly.
For example, suppose a single homeowner lived in and owned a main home for 12 months before selling because of a qualifying job relocation. Twelve months is 50% of the normal 24-month requirement, so the homeowner could potentially exclude up to $125,000 of gain instead of the full $250,000, assuming the other requirements are satisfied.
A seller may also qualify even when the circumstances do not fall neatly into one of the IRS’s listed situations. The IRS can consider factors such as whether the event was reasonably unforeseeable when the home was purchased, whether the sale occurred soon afterward and whether the event made the home significantly less suitable as a primary residence.
Reporting Your Home Sale on Your Taxes
If your profit on your home sale is less than the exemption amount and you meet the other qualifications, you do not have to report your home sale on your tax return.
However, if you exceed or don’t qualify for the exemption, you will need to report your home sale. Any profit that exceeds or does not qualify for the exemption will need to be reported as a capital gain under Schedule D.
You must also report your home sale if you receive a Form 1099-S. This form is distributed when you make a home sale, unless you assure your real estate closing company that you will not owe taxes on your profit.
If you do receive a form even though you qualify for the exemption, this doesn’t necessarily mean you owe taxes. However, it does mean that you will have to report the sale.
Estimate your capital gains taxes or your overall income tax liability below with our calculator to see how your earnings may affect what you owe.
Special Cases That Can Change Your Home Sale Tax Bill
Not every home sale fits neatly into the standard capital gains rules. If you sell a house you inherited, the tax basis is usually “stepped up” to its value on the date the previous owner died. This higher starting value often reduces the taxable gain; and in some cases, removes it entirely.
Additionally, selling a second home or rental property is different from selling your main residence. You typically cannot use the full primary residence exclusion, and if you claimed depreciation while renting it out, you may need to pay taxes on that amount when you sell. This tax on prior deductions is called depreciation recapture.
Life events, such as divorce, can also influence how the exclusion works. If one spouse keeps the home after a divorce, they may be allowed to use the other spouse’s ownership and residence history to meet the two-year rule. This can make it easier to qualify for the full tax break.
Sometimes, owners convert a rental property into their main home before selling. In these cases, the tax break may be split based on how long the property was a residence versus a rental. Only the portion tied to the time it was your main home would be excluded from capital gains taxes.
Special Rules for Homes With Improvements, Business Use or Multi-Unit Layouts
Some home sales require extra steps when calculating capital gains. If you made substantial improvements to your property before selling, those costs can be added to your cost basis. This includes projects that add value or extend the life of the home, such as major remodels, new systems or structural additions. Tracking these expenses can reduce your taxable gain.
Selling a home that was used partly for business can affect your tax bill, as well. If you operated a home office that qualified for depreciation, you may need to recapture that depreciation at the time of sale. Depreciation recapture is taxed separately from regular long-term gains and can increase the amount you owe.
Owners of multi-unit properties also follow special rules. If you lived in one unit as your primary residence and rented out the others, only the portion used as your residence is eligible for the home sale exclusion. The rented portion is treated as investment property, and any depreciation taken must be recaptured.
Casualty losses and insurance reimbursements can also change your basis. If you received insurance payouts for damage and then repaired the home, the basis may be adjusted based on the cost of the repairs compared to the reimbursement. Reviewing these details before the sale can help you calculate the correct taxable gain.
Bottom Line
Selling a house can trigger capital gains taxes when the sale price exceeds your adjusted basis, but many homeowners can reduce or eliminate that tax with the primary residence exclusion. Qualifying sellers may exclude up to $250,000 of gain, or up to $500,000 for many married couples filing jointly, while a reduced exclusion may be available when a home is sold early because of certain work, health or unforeseen circumstances. Keeping records of your purchase price, improvements and selling expenses can help you calculate the taxable gain more accurately.
Home Buying Tips
- When you’re navigating a big financial decision like buying a home, working with a financial advisor can be helpful. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- For guidance on state laws governing capital gains taxes, use SmartAsset’s free guide to capital gains tax rates by state.
- Trying to figure out how much you can reasonably spend on a house? Use SmartAsset’s home affordability calculator. This takes into account your annual income, including your debt payments, to determine how much house you can afford.
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