We used to get this question a lot….back in the mid-00’s, when people still had big capital gains built up in their homes. With the recent comeback in prices in Seattle, it’s getting asked again: “WHAT TAXES DO I OWE WHEN I SELL MY HOME?”
The longer answer is here, but the short answer is this….if you have a capital gain on your home, provided you’ve lived in the house for two of the five years prior to its sale, the gain is EXEMPT from capital gains taxes up to $250,000 for singles; or $500,000 on a joint return. The gain is your net sales price, after closing costs (excise tax, commissions, etc), minus your purchase price, minus capital improvements (remodels). This doesn’t include maintenance which is a normal cost of ownership (e.g. a new roof or paint).
Example (a real one, actually):
Purchase in 1983 in Denny Blaine, a nice neighborhood east of downtown Seattle: $375,000. Sales price in 2010: $1,400,000. The seller lived in the house for the duration, so easily met the primary residence test.
The gain is calculated as follows:
$1,400,000 — Gross sales price
($105,000) — closing costs on sale (1.78% excise tax, 5% commission, title, escrow)
($235,000) — cost of remodeling the kitchen and doing an addition, considered capital improvements
($375,000) — Original cost of the house
Capital Gain: $685,000
Exemption: ($500,000) — married couple filing jointly
Taxable Gain: $185,000
Taxes due at current long term rate of 15%: $27,750
This is really important if you have a gain, and you choose to rent the house after moving out for a period of time, waiting for the market to recover or if you were simply not sure if you’d move back into the house — due to a relocation, or change in circumstances. After three years of rental use, you no longer meet the criteria for this exemption to apply — you have not lived in the house for two of the five years prior to its sale. When we help our clients with property management in renting out their homes, we’re always sure to mark our calendars for that 2-2.5 year mark…if they want to sell and claim that tax exemption, that’s the time to do it.
Disclaimer: I am NOT an accountant, but this is my understanding of the IRS rules regarding this scenario. Please check with your own tax professional for advice on your specific situation.