The Housing Scene

Know What You Owe -- and What You Don't

Tax time is still months away. But if you sold your house during this summer's selling season -- or plan to sell in the next few months -- it's a good time to familiarize yourself with the tax consequences of your transaction.

In most cases, the gain on your sale is taxable. But you may not have to pay taxes on a large part of your profit, and you might pay no tax at all.

If you owned the home and used it as your principal residence for at least two of the five years prior to the date of the sale, Uncle Sam allows you to exclude part or all of your gain. The two-year period need not be continuous, either; all you need is 730 days out of the previous five years.

How much you can exclude depends on how you plan to file. If you are married and filing jointly, you can exclude up to $500,000 of your gain. But if you are filing as a single person, the limit is $250,000. If you sell your house for a loss, whatever money you receive is not taxable. But the loss cannot be deducted from your other income.

There are a whole bunch of exceptions to the capital gains rule regarding principal residences. For example, if a marriage, separation, divorce or spouse's death occurred during the home's ownership, or if you moved because of work, health or an unforeseeable event, these could affect your taxes. Read over IRS Publication 523, "Selling Your Home," for more detailed information.

To determine your capital gain, subtract your cost basis from the selling price.

Cost basis is more than the price you paid for your house. It also includes certain settlement fees, closing costs and commissions associated with the purchase, as well as the sale of the property.

Add to this the cost of significant capital improvements you made to the house. This does not include repairs, like fixing a plumbing leak; rather, it is something that adds value to the place, like a new deck, an addition or improved landscaping.

All of the improvements you've made over the years will increase your cost basis, which will, therefore, lower your potential tax liability.

At the same time, several things can go toward reducing your cost basis. A lower basis will boost your profit, and possibly your tax. Among other things, the depreciation you claimed for your home office will have to be reclaimed in this manner, as will tax credits for energy-related improvements.

This is somewhat tricky, so let's review:

Add what you spent for the house, say $250,000, and improvements of $92,500, for a total of $342,500. Now deduct for $50,000 for depreciation, and you get a total cost basis of $292,500.

Next, from your selling price, say $875,000, subtract $55,000 in commissions and fees for a gross profit of $820,000.

Finally, subtract your cost basis from your gross profit, for a total capital gain of $527,500.

In this example from Charles Schwab, after taking the $500,000 capital gains exclusion for you and your spouse, you owe capital gains on $27,500.

The IRS "Selling Your Home" document includes a great worksheet that will help you do the math on all this. But it should quickly become evident that you need to have kept good records if you expect to minimize the tax bite from selling a house -- not to mention prove to the government that you didn't fudge your numbers. So if you didn't do so for this house, do yourself a favor and do it for the next one.

One of the tax benefits taken by people who purchased their first homes between 2008 and 2010, the first-time buyers' tax credit, may have to be paid back. If you were a rookie buyer in 2008, the entire credit must be recaptured when you sell that house, unless you qualify for an exception. If you bought in 2009 or 2010, you don't have to pay back the credit unless you sold or gave up the place within 36 months of taking ownership. See IRS Form 5405 for details.

If your gain from selling your house is not taxable, you need not report the sale to the IRS on your tax return come next April. But if you can't exclude all or part of the gain, or if you choose not to claim the exclusion, you must report the sale on your tax return.

You should have reported your new address to the IRS when you moved. If you haven't done so already, fill out IRS Form 8822.

All of the publications and forms mentioned here are available, for free, at irs.gov.

And finally, realize that none of the above applies to rental and vacation properties, which are another ballgame entirely. Those are covered in IRS Publication 527.

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