When selling your house, you’re likely focused on getting the best possible price and perhaps finding your next dream home. But what about the tax implications of the sale? While taxes might not be the most exciting aspect of selling your home, understanding them is essential to avoid surprise bills and to make the most out of your property investment.
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Video : 5 Most Important Points to Know if You Are selling Your Home
1.Capital Gains Tax
The first important point to consider when selling your house is the capital gains tax. When you sell your home for more than what you paid for it, the difference is considered a capital gain, and you may have to pay tax on that amount. The IRS exempts a portion of these gains for those who meet certain requirements.
As of the last update (September 2021), if you’re single, you can exclude up to $250,000 of your gain from your income, and if you’re married filing jointly, the limit doubles to $500,000. However, to qualify for this exclusion, you must have owned the home and used it as your primary residence for at least two of the five years before the sale.
2.Home Improvements and Selling Costs
A second crucial point to understand is that any improvements made to the property or selling costs can be added to the cost basis of your home, reducing the taxable capital gain. For instance, if you initially purchased your home for $200,000, spent $50,000 on home improvements, and incurred $10,000 in selling costs, your cost basis would be $260,000.
If you’ve ever used your home for business or rented it out, you’ve probably claimed depreciation on your tax returns. Depreciation recapture is the tax on the gain realized on the sale of depreciable capital property. When you sell your house, you must recapture the depreciation and pay taxes on it. This tax rate is typically 25% but can vary depending on your income.
Keep in mind that if you sell the property for less than or equal to the adjusted cost basis, you don’t have to pay depreciation recapture tax. In case of a loss, it may be possible to offset other capital gains. Have you tested our depreciation calculator for home office?
If you’re planning to reinvest the proceeds from the sale of your home into another property, consider a 1031 exchange, named after Section 1031 of the U.S. Internal Revenue Code. This allows you to postpone paying capital gains taxes if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. There are strict rules about the timing of the purchase and the type of property you can buy, so it’s important to plan carefully.
For example , toqualify as a 1031 exchange, both properties involved in the exchange must be “like-kind,” meaning they must be of the same nature, character, or class as defined by the IRS. Then there are strict time limits for completing a 1031 exchange .These time limits are very strict and cannot be extended, even if the 45th day or 180th day falls on a weekend or legal holiday.
Lastly, don’t forget about state taxes. Depending on your location, you might need to pay state capital gains tax, transfer tax, or other types of tax on the sale of your home. State taxes can add significantly to your tax burden, so they should definitely be factored into your calculations when selling your house. If you are fortunate to be resident of any of the following states, you do not have to pay any capital gains tax to the state.
Capital Gains Tax Free States!
- South Dakota
- New Hampshire
Readers are advised to check the most recent tax regulations in your specific state because tax laws can change. Also, consider consulting a tax professional to ensure that you have the most accurate and up-to-date information.
While the information on this site - Internal Revenue Code Simplified-is about legal issues, it is not legal advice or legal representation. Because of the rapidly changing nature of the law and our reliance upon outside sources, we make no warranty or guarantee of the accuracy or reliability of information contained herein.