Moving house is arguably one of the most stressful life events. Not only are you uprooting life as you’ve known it, but you are also navigating the financial implications that come with selling your house. These include doing budgets to manage proceeds of the sale of your home and making sure you’re in good standing with Uncle Sam.
Selling your primary residence comes with certain tax implications which is why it is important to invest in adequate tax planning to help you minimize tax liabilities and maximize the financial benefits of selling your home.
Tax considerations for selling your primary residence
The Internal Revenue Service (IRS) defines a primary residence as a property you own and live in. The capital gains you make from the sale of your main home are taxable, but you may be able to exclude the first $250,000 of your home sale proceeds when filing your taxes. The exclusion is increased to $500,000 for married couples filing jointly.
Do you qualify for the tax exclusions?
To qualify for the Section 121 exclusion – which deals with the exclusion of gain from the sale of a principal residence – you must meet both the ownership test and the use test.
Ownership test: You must have owned and used your property for at least two years out of the five years prior to its date of sale
Use test: You must have used the property as your primary residence or main home for at least two years during the same five-year period.
If you meet both of these tests, you can exclude up to $250,000 in capital gains from the sale of your primary residence or up to $500,000 if married and filing jointly.
You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale. Generally, you’re not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.
Tax filing: reporting the sale of your home to the IRS
Schedule D (Form 1040), Capital Gains and Losses and Form 8949, Sales and Other Dispositions of Capital Assets are required for tax filing as part of your 1040 Form to report the home sale.
You must report the sale of the home if the capital gain from your sale exceeds the excludable amount. In ad hoc cases, you may receive an informational income-reporting document such as Form 1099-S, Proceeds From Real Estate Transactions.
The IRS instructs you to report the sale of your home if you receive any of these informational income-reporting documents, even if the capital gain passes the eligibility test for being tax excludable.
Other factors that influence proceeds of primary residence tax
Selling your primary residence or main home can be a complex process with various other factors that come into play when filing your taxes. These are some of the additional factors to consider:
- Time of sale: Both the use and ownership tests for the qualification of tax exclusion refer to time as an important consideration. When selling your property it is important to consider the two-year ownership and residency requirement, or you may be taxed on the entire profit from the sale.
- Tax deductible expenses: When submitting your taxes, there are several expenses that may be tax-deductible. These may include expenses of sale such as attorney fees and real estate commissions. You may also be able to deduct home improvement costs typically made within 90 days of the sale.
- Multi-state tax liabilities: State and local taxes can impact your tax liability when selling your primary residence. Some states have higher state capital gains tax rates than others. If you sell property in California or other states with higher capital gains tax rates, this would put more pressure on your profits. These along with federal tax requirements need to be taken into account when selling your primary residence. Furthermore, if the sale of your main home is to move to another state for retirement or lower income tax rates, then it is important to do thorough due diligence in this regard. Some states with no or lower individual income taxes may have higher property taxes and estate or inheritance taxes. A state may charge an estate tax against an entire taxable property, regardless of the ownership, and an inheritance tax against inheritances received by particular beneficiaries.
It’s important to note that there are specific eligibility criteria and limitations on the deductibility of these expenses, and careful considerations to take into account when selling your primary residence and saving on the taxes thereof. It is always best to consult with a tax professional to determine the right steps to take from a tax-saving perspective and to understand which expenses are deductible and to what extent.
Failure to make the necessary submissions could result in noncompliance penalties with the IRS. Contact a Fusion tax expert as soon as possible, if you need help. Our team can provide you with guidance on Form 1040 and the necessary steps to follow if you have sold your primary residence and need to report gains to the IRS.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
