As a homeowner, you should be aware of the income tax consequences of selling your home–knowing the rules can help you minimize any negative tax consequences. You should understand how to calculate capital gain, and know when capital gain can be excluded from taxation. You should also know what you can deduct on your tax return for the year of sale, and how closing costs are treated.
What are the income tax consequences of selling your home?
There may or may not be income tax consequences when you sell your home. If you sell your principal residence at a loss (i.e., for less than you purchased it), you generally can’t deduct the loss on your federal income tax return. If you sell your principal residence at a gain, you may be taxed on the capital gain. If you’re eligible, however, you may be able to exclude all or part of the capital gain from taxation.
TIP: This discussion applies to the sale of your principal residence only. For the tax treatment of the sale of your second home or vacation home, see our separate topic discussion, Special Considerations for Second/Vacation Homes.
How is capital gain calculated?
If you own your principal residence, it will generally be considered a capital asset. The sale of a capital asset normally results in either a capital gain or a capital loss. If the sale price of your home exceeds your adjusted basis (the initial cost of your home, plus amounts you’ve paid for capital improvements, less any depreciation and casualty losses claimed for tax purposes) in the home, you’ll realize a capital gain.
Tip: Capital improvements add value to your home, prolong its life, or adapt it to a new use. The installation of a deck or a built-in swimming pool would be an improvement. However, regular repairs and maintenance are not considered improvements and are not generally included in the tax basis of your home.
Example(s): Assume you bought a house for $150,000 and finished the basement three years later for $10,000. You sell the house several years later for $250,000. Your capital gain equals $90,000 ($250,000 – $160,000).
If your capital gain is taxable, you must report it on Schedule D of your federal income tax return. If deductions have been taken for business use for any part of the property (e.g., rental use, home office), the value of that part of the property may be treated differently (see below for more information).
When can you exclude your capital gain from income taxation?
In general
If you sell your principal residence at a gain, you may be able to exclude from taxation all or part of the capital gain. If you meet the requirements, you can exclude up to $250,000 (up to $500,000 for married couples filing jointly) of the capital gain from federal income tax, regardless of your age.
You can generally exclude the gain only if you owned and used the home as your principal residence for a total of two out of the five years before the sale (the two years do not have to be consecutive). An individual, or either spouse in a married couple, can generally use this exemption only once every two years.
Example(s): Assume you and your spouse bought a home for $200,000. You live in the home as your principal residence for 3 years (and file joint tax returns each of those years) then sell the house for $500,000. The entire $300,000 gain is excludable. That means you don’t have to report your home sale on your income tax return.
Special rules may apply in the following cases:
- If you sell vacant land adjacent to your principal residence
- If your principal residence is owned by a trust
- If your principal residence contained a home office or was otherwise used partially for business purposes
If you rented part of your principal residence to tenants, or used it as a vacation or second home (i.e., uses considered “nonqualifying” under the Housing and Economic Recovery Act of 2008)
If you owned your principal residence jointly with an unmarried taxpayer
Tip: Members of the uniformed services and foreign service personnel may elect to suspend the running of the 2-out-of-5-year requirement during any period of qualified official extended duty up to a maximum of 10 years.
Tip: Previously, a surviving spouse was entitled to the $500,000 exclusion only if he or she filed a joint return with the deceased spouse’s estate, which can only occur for the tax year in which the deceased spouse dies. The Mortgage Forgiveness Debt Relief Act of 2007 extended the period of time in which the surviving spouse has to take the $500,000 home sale exclusion. For sales on or after January 1, 2008, the sale of a jointly-owned and occupied residence is entitled to the $500,000 exclusion provided the sale occurs no later than two years after the date of the deceased spouse’s death.
Caution: For sales or exchanges after October 22, 2004, the exclusion does not apply if the residence was acquired in a like-kind exchange within the prior five years.
Reduced exclusion
What if you didn’t own and use the home as your principal residence for a total of two out of the five years before the sale? Or what if you used the capital gain exclusion within the past two years with respect to a different principal residence? You may still qualify for a reduced exclusion, assuming the primary reason for your home sale was because of a job relocation, for health reasons, or because of certain other unforeseen circumstances. In such a case, exclusion of the gain may be prorated.
Tip: Job relocation is defined simply as a change in the place of employment.
Generally, you must establish by the facts and circumstances of your situation that your home sale was for one of these reasons. The IRS has issued temporary regulations that clarify the meaning of the above conditions (change in place of employment, health reasons, unforeseen circumstances). In addition, there are various “safe harbors” that will automatically establish that a sale is for one of these reasons.
For more information, see IRS Publication 523, Selling Your Home.
What can you deduct on your income tax return for the year of the home sale?
If you did not rent your principal home to others (or if you rented it for fewer than 15 days during the year), you can deduct the following home-related expenses on your income tax return:
- Property taxes
- Qualified interest on loans secured by the residence
- Certain casualty losses
Tip: If you rent your principal home for fewer than 15 days a year, any rental income you receive is not considered taxable income.
Deducting property taxes on your income tax return
If you itemize your deductions on Schedule A of your federal income tax return, you may be able to deduct the property taxes you paid during the year for your principal home. A home seller is responsible for real estate taxes up to the date of sale. At the closing, you and the buyer divide the real estate taxes. You pay taxes up to (but not including) the date of closing. If you’ve already paid a tax bill for a period extending beyond the closing date, the buyer will reimburse you at the closing for that extra portion. This information should be provided to you on a settlement statement at the closing.
Deducting mortgage interest
You may be able to deduct qualified interest you paid on a mortgage to buy, build, or improve your home, provided that the loan is secured by your home. You may also be able to deduct the interest you paid on a home equity loan.
Deducting casualty losses
If you use your home only for personal (nonbusiness) purposes, you can’t deduct your homeowners insurance premiums on your tax return. However, if you suffer an insurance-related loss for which you are not fully compensated, you may be able to claim a casualty loss deduction on your income tax return.
Deductions if you rented your home to others, or used it for business purposes
Special deduction and income-reporting rules apply if your principal residence is a multifamily home, a portion of which you rented to tenants.
Special deduction rules also apply if you used a room within your principal residence as a home office. In such a case, you may be able to deduct some of your housing expenses (including part of your homeowners insurance premiums) on your federal income tax return.
How are closing costs treated when you sell your home?
Generally, you can’t deduct settlement costs on your income tax return when you sell your home. Often, however, if you pay certain settlement costs, such as a broker’s commission, points owed by the buyer, transfer taxes, and other costs owed by the buyer, you can reduce the amount realized (sale price). This can be advantageous, because it will decrease your capital gain.