By Jonathan Jones, CFP^®

Nationwide the real estate market has been booming for the past year and a half. Numerous variables have contributed to a hot real estate market, including but not limited to historically low interest rates, higher construction costs, and a decade of less homes being built than past decades. With home prices remaining elevated, many homeowners have considered selling their home. A common question we hear as financial advisors is “Will I owe taxes if I sell my home?”.

Your home is a capital asset. When capital assets are sold at a gain, the gains could be taxed differently than your normal wages or income. When an asset with an appreciated price is sold, the gains on the sale (sales price minus cost basis) are treated as either short-term capital gains or long-term capital gains in the year the asset is sold. A short-term gain is when the asset was held for one year or less and are taxed at your ordinary income tax rate. A long-term gain is when the asset was held for more than one year. Long-term capital gains receive preferential treatment and are taxed at either 0, 15, or 20 percent, which is dependent upon your taxable income that year.

However, the IRS tax code (Sec. 121) will allow the capital gains on the sale of your home to be excluded from taxation under specific limits if certain requirements are met. Those who file as “Single” on their tax return may exclude up to $250k worth of capital gains from the sale of their home. For those that file “Married Filing Jointly”, up to $500k of capital gains from the sale of their home may be excluded.

In order to avoid taxation on long-term capital gains from the sale of your home, certain requirements must be met. One rule is that the home must be considered your principal residence. Additionally, the taxpayer must have lived in the residence for two years within the five-year period preceding the sale of the home. Either 730 days or 24 full months will satisfy the two-year ownership and use requirements. Certain exemptions do exist if the two-year requirement is not met. Below is an example of when the gains on the sale of a home are excluded from taxation (not taxable).

EXAMPLE

John and Mary, who file their taxes as “Married, Filing Jointly”, originally bought their home as a rental property in 2015. The purchase price then was $150,000. They have not made any additional improvements to the home. They sold their home for $350,000 in 2022. Although it was originally purchased as a rental property, John and Mary have occupied this home as their primary residence for the past four years. The $200,000 in gains that resulted from the sale of their home are considered long-term capital gains and are excluded from taxation, according to Sec. 121 of the IRS tax code, because this home was their primary residence for atleast two years out of the previous five years before it was sold.

This material is being provided for information purposes only. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we do not provide advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.