The housing market in the US is finally starting to kick back in high gear, after a few years stalled on the wayside. With this recent shift in the real estate market, a review of the taxes (and appropriate tax breaks) associated with home sales is in order. The application of taxes can be tricky, as selling your primary residence that you live in full time could be free of taxes, however, taxes are applied to profits from the sale of a second or third home.
Primary residence tax break applies to anyone selling a principal residence. It allows sellers to enjoy a large portion of their profits, up to $500,000 for married couples who file jointly (half that for singles), tax free. Any profit above that amount is subject to long-term capital gains taxation rates. Currently, that rate is 20% to 23.8% on similar capital gains.
This tax break excludes the cost of the home and additional improvements, and only apples to profits. For example, if a married couple purchased a home for $200,000 and completed $50,000 in improvements, the “cost basis” for their home would be $250,000. With the additional $500,000 tax break, this couple could sell their home for as much as $750,000 before they would owe federal tax on the sale.
This tax break is available to homeowners every two years provided they have lived in the home for two years out of the last five. A qualifying residence can be a duplex, a condominium, a boat, or a mobile home, provided it has the appropriate toilet, sleeping and eating capacities.
There are special rules that are applicable in some instances. Widows and widowers can retain the $500,000 exclusion provided they sell the residence within the two years following their spouse’s passing.
If a seller has moved due to an employment change, a health need, or an unexpected circumstance such as death or divorce, and hasn’t met the two year requirement, a smaller exclusion can be applied.
The rules become complicated when you turn your vacation home into your primary residence. A prorated credit is available depending on how long you have been living there full-time.
For sellers who have rental income on their property, such as a garage or basement apartment, the tax regulations require that you account for your percentage of the property in which you primarily live. The rental unit must be considered separately.
In 2014, there’s a new tax of 3.8% on net investment income for couples with an AGI above $250,000 (200,000 for singles). This tax applies to gains from the sale of a home, but will most likely only be seen in the more expensive housing markets, like Los Angeles.
If the gain is greater than the total cost of the home, including improvements and the tax break, the tax will only apply to the amount about the benefit. Capital losses can be used to counteract these gains, if applicable.