What happens when you sell your home? How much taxes do you have to pay? What about the money that you put into the home, does that count? These are the type of questions we get when you decide to sell your home. Let’s dive into these one by one.
How to sell your home tax-free
Let’s jump into the tax-free sale of your house. Whether the sale is tax-free or not depends on your overall gain on the sale and how long you lived in the home. There are limits to how much can be tax-free.
You have the ability to exclude up to $250,000 (Single) or $500,000 (Married) of capital gains on the sale of your home IF you:
- Have owned and lived in the home for 2 years out of the last 5 years.
That’s it? Yes, that is it. If you have lived in the home for 2 out of the last 5 years then you can exclude those gains up to the limits above.
How to calculate your capital gains tax on the sale of your home
If you sell your house for 1 million, you need to know what your gain on that sale will be in order to know how much you will pay in taxes. Or better yet if you qualify for the exclusion.
In order to calculate your gain on the sale of your home, follow these 4 steps.
- What did you pay for the house?
- How much have you put in the house since you owned it in improvements? I.e. Kitchen Makeover, etc
- Add in the costs to buy (Look at your HUD Statement for these)
- What will you sell the house for less selling expenses?
Let’s take an example:
You bought a house and have lived in it for the last 5 years for $250,000. You love the house renovation shows and have done some HGTV type improvements--- open concept, new floors, new kitchen, etc. But you have a growing family and are ready to get a bigger home for more space. Let’s say the market has gone up a lot and now it’s worth $900,000.
What is your gain? You need to determine your cost basis or what you have invested in your home.
- What did you pay for the house? $250,000
- How much have you put in for improvements? $50,000
- What were the costs to buy your home? Closing Costs $5,000
- What will you sell it for less selling expenses? $900,000 less $50,000 (closing costs/ realtor fees) = $850,000
What will your gain be?
- $250,000 House
- $50,000 Improvements
- $5,000 Expenses
- $305,000 What you have in it (Cost Basis)
- $850,000 Sale less selling expenses
- -$305,000 What you have in it (Cost Basis)
- $545,000 Gain on sale
Now that you know how much gain on the sale there will be, the next question is do you qualify for any exclusion?
Did you live in the house for 2 out of the last 5 years? YES, you lived there 5 years
Are you single or married? $250,000 or $500,000 exclusion. Married and you both lived there for 5 years= $500,000
- $545,000 Gain
- -$500,000 Exclusion
- $45,000 Home gain after exclusion
So how is the $45,000 remaining taxed? Selling your home will be subject to capital gains.
There will either be short term capital gains or long term capital gains. If you have lived there for a year and a day then you would be subject to long term capital gains. Long term capital gains will be taxed from 0% - 23.8% depending on your total income for that year.
If you are a Dentist making $300,000 then you will pay capital gains taxes at 23.8%.
What about your mortgage? How does your mortgage affect your gains on your home?
What I see from a lot of people is mortgage confusion. Let’s add on to the example above and a year before the sale you refinanced your $250,000 mortgage for $850,000. You used the additional $600,000 from the refinance to pay down student loans, credit cards, purchase new cards, a boat, and some great vacations.
You then sell the home and after selling expenses the mortgage is paid off, but you receive no additional money. It can be confusing that since you didn’t receive any cash at the sale that you won’t owe any taxes. That’s not always true. Taking the example above you would still have $45,000 in gains subject to long term capital gains even though you received no money. The reason is you have already taken out your gains from the house.
Even though that may be an extreme example, your mortgage doesn’t have anything to do with the gain on the sale. I would recommend in general, not to count your mortgage just focus on the calculation steps above.
What happens if I didn’t live in the house for the last 2 years, will any be tax-free?
In general, you do have to live there for 2 out of the last 5 years. If you didn’t then you could qualify for a partial exclusion If you moved due to unforeseen circumstances. Those can be:
- Moved to a new state for a job change
- An owner of the house died
- Divorced or legally separated
- Job Loss (become eligible for unemployment)
How much will I pay in capital gains taxes on the sale of my home?
In general, if you exceed the exclusion or don’t qualify then you will either pay short term capital gains tax or long term capital gains tax.
Did you own the house for a year and a day? If yes then it's a long term capital gain. If not, then it’s a short term capital gain.
- Long Term capital gain rates range from 0% - 23.8% depending on your total income
- Short Term capital gain rates are the same as ordinary income rates.
I sold my home for a loss, can I deduct the loss on my taxes?
The IRS doesn’t allow a loss on personal items and a house is a personal item. Unfortunately, you can’t take a loss on the sale of your personal residence.
When you sell your home and live there for at least 2 years out of the last 5 years, there is a huge upside in being able to access the home exclusion. Understanding how to calculate your gain on the sale of your home, whether you qualify for the home exclusion and avoiding the mortgage confusion is the best way to know whether you can sell your home tax-free.