If you are considering selling your home, there are a few things to keep in mind in order to minimize your tax risk.
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If you are selling your home for a profit, you are allowed to shelter up to $250,000 of profit if you are single and up to $500,000 of profit if you are married filing a joint return. But you can only shelter the money if you lived in the home for two of the last five years prior to the sale. And you cannot have gone through a sale in which you excluded the gain during the prior two years before the sale of the current home.
If you are able to exclude the gain, you don’t have to report the sale on your income tax return. If you do have a gain, report it on form 1040, Schedule D, Capital Gains and Losses. A loss on the sale of a personal residence is not deductible.
Any gain above the exclusion level is subject to income tax, so be sure you have calculated in every dime to your basis in order to reduce your tax. Here is what you can add to the original cost of the home:
- Closing costs from the original purchase and from any refinancing or equity line loans secured by the property that were made over the course of your ownership;
- Capital improvements made to the residence can be added to basis. For example, new hot water heater, roof, windows, landscaping. Do not include costs for painting or basic maintenance;
- Costs of any additional assessments paid over the years that were never
notdeducted on tax returns.
You may be required to add back to basis any depreciation claimed in prior years, but check regulations to determine how to handle this with regards to home office deduction or any rental activity.
From the selling price of the home you may deduct the realtor’s commission, closings costs and any agreed upon costs to fulfill the contract. For example, you could deduct a $5,000 reduction in escrow for roof repairs.
If you are selling a vacation home or a second residence rather than your main residence, you are required to pay tax on the gain from any second home. Your main residence is considered to be the home in which you spend most of your time.
If you are in a position in which you have had to short sale your home, you may be subject to taxes based on income generated by loan forgiveness. But this only comes into play if the loan forgiveness exceeds $2 million on your personal residence. There is no exclusion if it is a rental property . However, in most of the cases I have handled, no tax was due because the taxpayer could prove insolvency or had filed bankruptcy.
To determine insolvency, you would compile a list of all of your assets and all of your debts the day before the short sale took place. If you arrive at a negative number after subtracting debt from assets you are considered insolvent to that extent. For example, your assets, including the home you are short selling total $500,000. Your debts, including the balance of the mortgage on your residence, total $720,000. You are insolvent to the extent of $220,000. If the loan forgiveness totals $250,000, you would be required to pay taxes on $30,000 of loan forgiveness.
If you were lucky enough to have enjoyed the First Time Home Buyer Credit, you will have to follow special rules. So check Publication 523 or check with a tax pro to find out how that applies to you.
For more information on selling your residence refer to IRS Publication 523.
And don’t forget to provide the IRS with your new address by using IRS Form 8822.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.