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What Is The Tax When You Sell A House?

What Is The Tax When You Sell A House?
by Jerome Foster - September 14, 2022,

Selling a property is an important life event. But before you can focus on purchasing a new home, you must figure out how to correctly report any earnings from the sale of your current home. Such profits are referred to as capital gains. This may impact your financial plan, as you may receive a significant windfall of cash and incur additional taxes. Tax breaks, reduced exclusions, how to record your home sale on a tax return, and how to calculate the overall profit from your home sale are among the topics covered. Before selling your home, it may be prudent to consult a financial counselor.

Do You Have to Pay Taxes on the Sale of a House?

When you sell your home for a profit, you may be required to pay capital gains tax. However, there are circumstances in which you may be required to pay zero or very little tax.

If you are single and have resided in your home for two of the preceding five years, the first $250,000 of any profit on the sale of your home is exempt from taxation. The tax-free amount climbs to $500,000 if you are married and submit a joint tax return with your spouse.

It is essential to emphasize that these data pertain to profit, not revenue. This means that the tax is dependent on the net amount you gain from selling your home after deducting expenses. The difference between the original buying price and the sale price. In turn, if you sell your home for less than $250,000 above your purchase price and have lived in it for at least two of the preceding five years, you will not owe any taxes on the sale of your property.

How To Determine The Profit of Your Home Sale?

Consequently, you will need to compute your profit from the sale of your home in order to establish if you owe taxes on the sale of your home. This computation is not as straightforward as subtracting the purchase price from the selling price.

You must first determine the cost basis of your home. You must examine not only how much you paid on the home's acquisition but also how much you've spent on expansions and improvements. So, let's assume the original purchase price of your home was $200,000 and you paid $20,000 to build an extra room. Then, $20,000 will be added to your cost base.

Next, record the selling price of your home. You will then deduct any fees, such as closing costs and real estate agent fees, from this sum. If you sold your home for $300,000 but paid $10,000 in fees, you netted $290,000 from the sale.

Now, deduct your cost basis from your overall profit from the transaction. In this instance, $290,000 less $220,000 yields a profit of $70,000. Since this amount is less than $250,000, you owe no taxes on the sale of this residence.

How to Qualify for Home Sale Tax Breaks?

There are three fundamental elements that must be met in order to qualify for a tax break. Here is a summary of them:

  • You must have owned the home for at least two years before selling it. If you have owned your property for less than three years, you are not eligible for tax relief.
  • At least two of the past five years must have been spent in the home as your principal residence. This means that second residences, including vacation homes and rental properties, are unlikely to qualify for this tax relief.
  • You cannot have utilized this tax deduction for the sale of another home within the previous two years. This means that if you are attempting to sell numerous properties, only one of them will qualify for the tax reduction.
  • If you meet these requirements, you may qualify for the tax benefit. Clearly, this will significantly improve your chances of selling your home for a profit.

Qualifying for a Reduced Home Sale Exclusion

A partial exclusion of gain, also known as a reduced exclusion, permits you to claim a portion of the tax benefit even if you do not meet all of the aforementioned standards. For instance, if you have only resided in your property for one year, you could be excluded from paying taxes on up to $125,000 of your earnings from selling your home.

However, you must have a valid explanation in order to qualify for a reduced exclusion. Changes in job, health or any other unforeseen condition that necessitates you to sell your house sooner than anticipated are valid reasons.

Reporting Your Home Sale on Your Taxes

If your profit from the sale of your home is less than the exemption amount and you meet the other requirements, you are excluded from reporting the sale on your tax return. If you exceed or do not qualify for the exemption, you must record the sale of your home. Profits in excess of or ineligible for the exemption are taxed as capital gains on Schedule D.

You must also disclose the sale of your home if you get a Form 1099-S. This paperwork is provided upon the selling of a residence. Unless you ensure the closing business, you will not owe taxes on your profit. If you obtain a tax form despite being exempt, this does not necessarily mean you owe taxes. Nonetheless, you will be required to declare the sale.

Conclusion

While it is possible that you will be required to pay taxes on the sale of your house, the likelihood is that you will not. If you follow a few easy rules, you can sell your property tax-free and retain up to $250,000 in profit. This number increases to $500,000 if filing jointly. In fact, if you owe no taxes, you do not even need to report the sale of your house on your tax return. Any taxable profit falls within the standards for capital gains.

Read more: What Income Do I Need To Buy A House?

Author

  • Jerome has worked for an international real estate magazine in the past before joining Prudentialcal. He now spearheads our team of writers and ensures the quality of content we produce weekly.

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