Will I Pay Income Taxes on the Sale of My Home?
For many Americans, their homes are their greatest financial asset. While most are well aware that Uncle Sam offers significant tax incentives when buying or selling a piece of real estate, they are also unclear as to the specific qualifying criteria. Does every homeowner who sells a property get the same amount of exemptions? Or do people over the age of 55-years old get a better deal? Do the same rules apply to the sales of second homes or rental properties? When homeowners are uncertain of the tax laws before selling a home, they can easily lose money in the transaction.
Selling a Primary Residence
There are three basic criteria that any homeowner must meet before benefiting from the income tax exemptions for selling a primary residence. In most cases, the average American can walk away with nearly 100% of the profits from a home sale completely tax-free. For those who meet the following three guidelines, the filing of income tax returns remains relatively quick and painless, at least concerning the sale of the home.
The home must be the primary residence of the homeowner for at least two years of the preceding five years of the home sale.
The IRS denies eligibility to any homeowner who has already previously claimed this tax exemption on the sale of a primary residence within the previous two-years.
The home must be the primary residence of the owner(s) for at least 24-months or 730 days in the five years preceding the sale. During the remaining three years, the property owner can even rent it out to tenants as a way of covering the mortgage.
Furthermore, the IRS does not require the homeowner to live in the primary residence on the day of the transition. As an example, a homeowner can live in the residence for the first two years before renting the property to a tenant for another three years prior to the sale of the home.
Another significant advantage of the capital gains tax code is that this two-year requirement does not have to be consecutive either. As long as the total length of time adds up to 24-months or 733 days, the homeowner reaps the benefits of the income tax exemption.
The good news is that homeowners who meet all three of these simple guidelines can claim up to $250,000 in profits for single-filers and up to $500,000 in profits for married couples filing jointly. In short, the IRS allows the homeowner to exclude this massive amount of "income" from personal income tax. However, the government is far less agreeable concerning homeowners who sell their properties at a loss. Unfortunately, they cannot claim these losses as deductions.
Second Homes and Rental Properties
The capital gains tax implications for the selling of rental properties and second homes are a bit more severe than with a standard sale of a primary residence. For the sale of a piece of rental real estate, the IRS bases the capital gains taxes on property depreciation values. In cases where the property consistently loses money over the course of ownership and the owner claims this money as losses in previous year's income tax reports, the eventual selling of the home can lead to an enormous amount of capital gains taxes due to Uncle Sam.
For sellers of second homes, there is a 14-day rule that is strictly enforced by the IRS. Since many owners of second homes sometimes rent them out "during the off-season," the IRS allows only 14-days of rental use for the entire year, or in some cases less than ten-percent of total usage. In both cases, the property owner can take advantage of lots of other deductions to make up for the ineligibility of the capital gains exemption. They can deduct all kinds of rental expenses, including utilities, marketing, property manager fees, insurance premiums, and even 50% of the depreciation.
However, because the IRS tax regulations regarding rental properties and second homes are so complex with lots of overlapping qualifying criteria, most owners tend to seek professional assistance from a reputable tax attorney or CPA before selling these types of properties. By selling too soon or before meeting all the proper criteria, what looks like a highly profitable home sale can turn very ugly very quickly. For more information on selling a primary, secondary, or rental home, propertyowners can consult the IRS Publication 523 - Selling Your Home.