We recently sold our home in Washington and moved to Texas. We made more than the $500,000 profit on the sale so will owe capital gains tax on the amount over $500,000. Over the course of the years we made some improvements to the house so our cost basis would be more than the original sale price. What sort of things can be included in the adjustment to the cost basis?
Thank you for your excellent question!
I'll first address items that can increase your basis in the home for tax purposes and then go over the home gain exclusion just to make sure you have clarity as well.
Your liability will be determined by the amount you sold the home for, minus any fees and expenses related to the sale, minus your basis in the home (what you originally paid for the home and any improvements).
When you make a home improvement, such as installing central air conditioning or replacing the roof, you can't deduct the cost in the year you spend the money. But, if you keep track of those expenses, they may help you reduce your taxes in the year you sell your house.
This article addresses all these items and is a good reference to keep around:
After that, depending on your circumstances, you may be able to exclude $250,000 to $500,000 of any potential gain from income tax.
Do I have to pay taxes on the profit I made selling my home?
It depends on how long you owned and lived in the home before the sale and how much profit you made.
- If you owned and lived in the place for two of the five years before the sale, then up to $250,000 of profit is tax-free.
- If you are married and file a joint return, the tax-free amount doubles to $500,000.
The law lets you "exclude" this profit from your taxable income. (If you sold for a loss, though, you can't take a deduction for that loss.)
- You can use this exclusion every time you sell a primary residence, as long as you owned and lived in it for two of the five years leading up to the sale, and haven't claimed the exclusion on another home in the last two years.
- If your profit exceeds the $250,000 or $500,000 limit, the excess is reported as a capital gain on Schedule D.
How do I qualify for this tax break?
There are three tests you must meet in order to treat the gain from the sale of your main home as tax-free:
- Ownership: You must have owned the home for at least two years (730 days or 24 full months) during the five years prior to the date of your sale. It doesn't have to be continuous, nor does it have to be the two years immediately preceding the sale. If you lived in a house for a decade as your primary residence, then rented it out for two years prior to the sale, for example, you would still qualify under this test.
- Use: You must have used the home you are selling as your principal residence for at least two of the five years prior to the date of sale.
- Timing: You have not excluded the gain on the sale of another home within two years prior to this sale.
If you're married and want to use the $500,000 exclusion:
- You must file a joint return.
- At least one spouse must meet the ownership requirement (owned the home for at least two years during the five years prior to the sale date).
- Both you and your spouse must have lived in the house for two of the five years leading up to the sale.
I hope this helps!
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