The housing market is at the top of its game these days and your friends are suggesting that you sell your home. You know you will receive multiple offers and probably sell the house over what you are asking for it. Do your homework to ensure that a sale won’t cost you more in taxes than you are putting in your pocket. Your tax advisor should be the first person that you call even before letting your real estate agent put a sign in your yard. Here are a few things you will need to know:
- When did you originally purchase your home and for how much?
- Have you substantially renovated this home over time? What did you do and how much did it cost?
- How long have you actually lived in the home as your primary residence?
- Have you ever rented out your home?
- How much are you expecting to sell the home for?
You may be asking yourself why your tax professional is so nosy. The answers to these questions will enable your tax advisor to determine whether you will have a big tax bill due or not in the year of the sale. For instance, if you have lived in the home for two of the last five years, and you haven’t rented it out, then you can exclude up to $500,000 of your gain on the sale from being taxed (the exclusion is only $250,000 for single taxpayers). This is a potential tax savings of $100,000 for married couples. Not too shabby.
Now, alternatively, say you have owned the home for eight years. You lived in the home for the first two years and the last two years, but you rented the home out for the four years in the middle. This can have severe tax implications for several reasons. First, any depreciation deduction taken to offset rental income will be deducted from the purchase price of your home, thereby increasing any gain you might have. Since you did live in the home for two of the last five years, you can take a homeowner exclusion still, but it will be reduced. You are eligible to take only 50% of the homeowner exclusion, $250,000 for married couples or $125,000 for a single person, because you only used the home for four of the last eight years as your primary residence. If you only lived in the home for one of the last five years you would lose 100% of your homeowner exclusion and the entire gain would be taxable to you.
There are other factors to consider when you use your home as a vacation property, deduct expenses for a home office, or otherwise use the home for anything other than your primary residence so make sure you contact your tax professional to talk over your plans before you sell. A little planning ahead of time can keep you from giving your profits away to the tax man.
As always, our CPAs at Mason + Rich are ready to answer any additional questions. Feel free to call us at 603-224-2000.