The capital gains tax on real estate sold depends on the type and use of the real property. The tax rate will depend on whether the home was a residence, vacation home or rental property. Calculating and reporting the gain on a home sale is pretty straight forward and is reported on Schedule D of your personal tax return. The seller would determine the cost basis by adding the purchase price (including closing costs), cost of improvements and selling costs, then deduct any accumulated depreciation which then equals the Cost Basis. Deducting the cost basis from the selling price determines the net gain or loss.
Below are 4 tax facts you should know before selling a home.
1. Residence: When the sale of a residence is completed, the tax rate is applied to any profits above $250,000 for an individual or $500,000 for a married couple. According to the IRS, the definition of a residence is a home that you have owned and lived in for at least 24 months in the 5 years prior to the closing. The 24 months need not be consecutive either. The seller gets to claim this exemption once every two years. If the seller lived in the home for less than the mandatory 24 month period, a portion of the gain may be excluded if you had to move due to employment reasons, health reasons or unforeseen circumstances. Be prepared however to provide documentation to back up any reason for a partial exclusion.
2. Secondary or Vacation Home: The capital gains exemption on secondary and vacation home sales were pretty much eliminated by the Housing Assistance Act of 2008. The seller can still take a partial exemption if they lived in the secondary home for 24 months of the preceding 5 years of the sale. The amount of
the exemption will be based upon the percentage of time the home could be claimed as a residence. The seller could also consider doing a 1031 exchange. This exemption takes place when the seller invests all profits into another property within a specified period of time. To qualify for the exchange, the 1031 (like-kind) property must be considered a rental property and not a residence. That means the property must be rented out for 15 days or more and you use it personally for less than 14 days or 10% whichever is
3. Rental/Income Properties: The 1031 exchange is currently the only way of avoiding capital gains tax on rental properties. As described above, the gains on the sale must be used to buy another rental property. There are no limits on how many times a seller does a 1031 exchange so the seller is enabled to trade up with each transaction by using the profits from the prior transaction.
4. Gifting to a Charitable Remainder Unitrust: Another allowable way to forgo capital gains tax is to gift the property to a charitable trust. This allows the donor to receive an income from the property. By gifting the real estate to an established charitable trust, the donor avoids the up-front capital gains tax, and then when
the trustee sells the property, the proceeds can be used to provide the donor with a lifetime income. In addition to the income, the donor receives an income tax deduction based on what the charitable organization will receive which is usually about 35% of the asset (gift) value.
The information above is intended to provide only a basic understanding of current real estate capital gain taxes/exemptions. Please seek the advise of a certified public accountant for details regarding your specific situation.