If you sell your home for more than you paid for it, you might have to pay taxes on your profit.
Luckily, the IRS allows an exemption for homeowners selling their primary residence. Usually, it’s $500,000 for married couples, and $250,000 for individuals.
This article covers the basis of that exemption, which the IRS calls the Section 121 Exclusion:
- Section 121 Exclusion basics
- How to qualify for a Section 121 Exclusion, or capital gains exemption
- How much is the exemption?
- Investment properties – how to qualify for the exclusion
Section 121 Exclusion Basics
The current 121 exclusion was established by the Taxpayer Relief Act of 1997. This allows home sellers to exclude all or part of their gain from the sale of their primary residence. Individuals can exclude $250,000, and married couples can exclude $500,000.
Usually, you have to report any earned capital gains to the IRS. For example, if you buy a painting for $500,000 one year, and then sell it for $600,000 the following year, you have earned $100,000 in profit. You have to report that profit to the IRS, and pay capital gains tax on your profit. Depending on your tax bracket, it may be 15-20%.
Back in 1997, a $250,000 or $500,000 exclusion probably covered all of the gain of the sale of a home. Many homes were valued at less than $500,000 back then. Today, not so much. If in an individual bought their home for $300,000 in 1999, and wants to sell it today, it’s important to consider tax liability.
How to Qualify for a Section 121 Exclusion
The basic qualification for a capital gains exclusion is time – the property needs to be your primary residence for at least two of the past five years. If the property isn’t your residence, if doesn’t qualify for the exclusion.
How Much is the Exclusion?
Usually, the capital gains exemption is $500,000 for married couples filing jointly, and $250,000 for individuals.
Calculating profit is more than just comparing the original purchase price to the finalsales price. Talk to your CPA about calculating your basis. For example, you may be able to add buying and selling costs, as well as improvement costs, to the purchase price, which can decrease the amount of taxed “profit.”
Investment Property Sales and the 121 Exclusion
If you move into an investment property, and live there for at least two years, you will be able to sell it. Remember, the property needs to serve as your primary residence for at least two of the past five years. Also, you may use this tax break, at most, only once every two years.
If the 121 Exclusion won’t apply, you may want to read my article about the 1031 Exchange.
You can also check out IRS Publication 523, “Selling Your Home.”
Thinking about selling your home? Contact me for a value estimate, and a net proceeds estimate.
