What are Capital Gains?
Capital gains are any profit you make when selling any capital asset you own. Most assets, from stocks to your house to your TV, are going to be capital assets.
If you sell something for more than you originally paid for the asset, the difference is a capital gain. Capital gains are supposed to be reported on your taxes as income.
A house sale is one instance where you are possibly going to make a large capital gain.
What is the exclusion to paying capital gains taxes when selling my home?
Before 1997, when you sold your house and made a profit, you had to pay taxes on the gain. When the Taxpayer Relief Act of 1997 was passed, Americans were given a break from the capital gains tax with an exclusion specifically for gains made from the sale of a home.
What was passed with this act in 1997 still stands. IRS Publication 523, Selling Your Home provides rules and a breakdown of the capital gains tax exclusion.
If you are single, you get to exclude $250,000 of gains from taxes. For 2 people, or a married couple, you get a $500,000 exclusion.
For the average person, this amount is going to be more than enough to cover whatever gain they would make from the sale of their home. Included in the initial price you paid for the home is also the money you put into improving it.
There are rules in order to qualify for this exclusion.
First, you must have owned the home for a total of 2 of the last 5 years before the sale.
Second the home must be considered a primary residency based on IRS rules. This means you must have occupied the home for 2 years in this same 5 year period.
You are also only able to qualify for this exemption every 2 years, so you can not sell a house every year and exclude the gains from your taxes.
We have helped clients move their main residence to their beach house or second home in anticipation of selling in the future. These rules need to be followed in order to qualify for the exclusion. If you make a mistake, it can be very pricey.
Why would I want to take advantage of the capital gains tax exemption in retirement?
We have a client who wanted to sell her family home and downsize into a townhouse when she retired. She wanted to split the money from the home sale between her 2 children and came to us to find out how much she would have to pay in taxes first.
When she bought the house, she paid $133,000. She ended up selling it for $300,000. We were able to tell her that she was going to owe no taxes on the sale of her home, since the gain of $167,000 was under the $250,000 limit.
Many retirees go through this exact same situation. If you’re thinking about downsizing, relocating, or even selling your parents house after they moved into assisted living or a nursing home, it pays to talk to professionals who have already assisted others through this situation. Cardinal can help you today!
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