If you sell your home, vacation home or rental property, Uncle Sam is peering over your shoulder trying to determine if he can have a piece of the pie. Although taxes should not be an overriding concern, a general understanding of how your decisions affect your tax bill is imperative. The gain on the sale of your principal residence may be subject to different tax treatment depending on how you used the home.
The Housing and Economic Recovery Act of 2008 modified the home sale exclusion for your principal residence. Generally, you can exclude up to $250,000, or $500,000 for those married filing jointly, in gains from the sale of your principal residence from taxes. Your principal residence is considered the home in which you spend most of your time during the year and that you have an ownership interest in. The home must also be used as your principal residence for at least two of the past five years. Unfortunately, you cannot deduct a loss on the sale of a principal residence.
How you calculate the gain is important too. If you paid $100,000 for your home and you sell it for $300,000, your gain is likely not $200,000. Over the years, you have probably put improvements into the home through upgrades, renovations, etc. These improvements adjust your cost basis in the home. You can also deduct seller expenses such as commissions, advertising costs, legal fees and closing costs from the final selling price before deriving the gain on the sale of your home. So, if you invested $50,000 in improvements and paid $3,000 in closing costs, your gain would be $147,000. Since there are so many ways to reduce the gain, the home sale exclusion generally covers most sales in the country.
Calculating the gain on your principal home sale becomes complicated if you have rented out a portion of your home. Rental property is considered an investment; therefore, the IRS does not allow a gain exclusion on a rental property. If you’ve rented out a portion of your home, you have to allocate a portion of the sale price and your basis to the rental portion of the house. You will have to recognize the gain on that portion of your home sale.
Complicating the calculations further, if you have taken depreciation deductions on the rented portion of your home, the sale is subject to depreciation recapture. For example, if you purchased your home for $100,000 and you sell it for $200,000, your gain is $100,000. However, if you have depreciated the property at $3,000 a year for the last five years, your gain is actually $115,000. Furthermore, the gain on the deprecation recapture is taxed at 25%. Depreciation recapture can also affect homeowners who depreciated a portion of their home as a home office.
Of course, calculating your actual gain is never this cut and dry. Additionally, if you are renting out a portion of your home, your rental income may be considered either a business or rental activity, and that classification can affect how you prorate your itemized deductions like mortgage interest and property taxes, which in turn, may eventually affect your gain when you sell the property.
There are many special situations that may require more information before excluding the gain on the sale of your home; therefore, it is often in your best interest to seek the advice of a qualified tax professional. If you have questions regarding the sale of your home, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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