Primary Residence Capital Gains Exclusion – Boring But Necessary
Homeowners can usually avoid capital gains taxes when they sell their primary residence for a profit.
Individuals can exclude $250,000 of gains, and married couples can exclude $500,000 – if they meet certain guidelines.
Most people in the real estate and mortgage industry are aware of this in general, but they don’t understand the specifics (and they should 😊).
Homeowners first need to know their tax basis before they can figure out their gains.
Your tax basis is the cost of buying, building, and/or improving a property. For example, if you buy a home for $200,000 with an additional $5,000 in closing costs and then spend $45,000 in upgrades, your tax basis is $250,000.
WHAT IS YOUR CAPITAL GAIN?
To find your capital gain, simply subtract your tax basis from the sales price of your home, net of the costs of the sale, e.g. sales commissions, transfer taxes, etc.
Using our above example, if you sell your home for $500,000 and incur $50,000 in sales expenses, your capital gain would be $200,000. ($500,000 sale price – $50,000 of sales expenses – $250,000 basis = $200,0000 of capital gains).
GETTING THE PRIMARY RESIDENCE TAX EXCLUSION
You can avoid the capital gains tax if the property is your “primary residence” and you have lived in the property for at least two of the last five years. This is formally called Principal Residence Exclusion. As mentioned above, married couples can exclude $500,000 of gains, and individuals can exclude $250,000 of gains.
In our above example, the $200,0000 of gains would not be subject to capital gains taxes for either an individual or a married couple as long as they lived in the property for two of the last five years.
1. High earners (over $200,000 of income for individuals and $250,000 for couples) may be subject to an additional 3.8% Federal “Net Investment Tax.”
2. Homeowners can take advantage of this Principle Residence Exclusion every two years.
3. See your CPA. The above description is overly simplified, and as always we recommend consulting with your CPA or tax advisor for further clarification.
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