Selling Your Home? Here Are 3 Tips to Minimize Capital Gains Taxes
To put it lightly, home prices tanked during the financial crisis. The S&P Case-Shiller 20-City Home Price Index fell from from more than 200 to as low as 140, a decline of about 30 percent, and the 10-City index fell by about 33.4 percent. In a just a few years, home prices had lost pretty much every dollar of value they had added during a meteoric rise in the first half of the decade.
Odds are, if you own your home, the idea of a sale in recent years has been unattractive to you for exactly these reasons. The last thing you want to do during an economic recession or an anemic recovery is sell your home for a loss, so if they could, many people held on to their homes, hoping that prices and the market would recover.
The S&P Case-Shiller indexes haven’t yet recovered to their pre-crisis levels, but at 165.8 for the 20-City and 180.15 for the 10-City, they are each sitting at about 80 percent of their pre-crisis peaks. This is healing — if not outright health — in most major real estate markets, although at 79 percent of its pre-crisis peak, the national-level index is slightly weaker.
The time may be right to sell, and to hopefully sell at a gain instead of a loss. If this is the case, you can expect a fiscally weary Uncle Sam to reach out his hand and ask for a cut of the proceeds. Fortunately, there are a few provisions in the tax code that can help you pocket your profits and build your life wherever it is you move next. Click through to see a few tips to minimize capital gains taxes on the sale of your home.
1. Sell your home, not your house
When you sell your home and make a profit, you are allowed to exclude a certain amount of that money from your taxable income. The amounts are $250,000 if you are an individual and $500,000 if you are married and filing jointly. This is a sweet, sweet deal for those who are being forced to relocate for work or to accommodate a growing family. These profits can go a long way toward covering moving expenses, the purchase of a new home (or a downpayment on one), or could be put to use in a college fund or retirement account.
There are a couple of exceptions to this rule, though. Perhaps the most visible one is that the home you sell must be actually be your home, not just a house you own. The difference may seem arbitrary, but it’s meaningful from a tax standpoint. In order for the house to count as your home, you had to have lived in the building for two out of the past five years. These years don’t have to be consecutive, but you won’t qualify for this tax exclusion if you sell a vacation house that you live in for two or three weeks a year.
It’s important to point out that many types of residences can classify as a home. If you live on a boat, that should be OK. Mobile homes, apartments, condos, and townhouses should also all qualify for the exclusion. Just make sure that if Uncle Sam pokes around, you can make a good case for why the residence was your primary one. You can also only claim this exclusion every two years, subject to certain conditions.
2. Keep a diary
If you own property, it’s a good practice to keep a record of everything that you can. There are a thousand reasons why receipts and documentation could prove useful, and minimizing your tax bill is one of them. There are a couple of exceptions and conditions that apply to the capital gains exclusion, but if you take advantage of these exceptions or the conditions apply to you, you’ll want a legible paper trail for the Internal Revenue Service to follow should the agency come knocking.
For example, if you are forced to sell your home after having lived in it for less than two years because of an illness or an accident that hospitalizes you, you can still claim a partial exclusion. If this happens, you should keep your receipts and get a letter explaining the situation from your physician. These documents don’t need to be submitted with any tax filing, but getting them ahead of time sure beats calling the doctor back two years down the line and asking if he or she remembers who you are.
The same applies for a battery of other unforeseen circumstances, including natural disasters. In most cases your home won’t be worth as much after it gets hit by a hurricane, automatically disqualifying you for a tax exclusion for any profits made on a sale, but the value could increase after repairs are completed (why not replace those flooded-out carpets with wood?).
3. Partial exclusions
There are three primary exceptions to the rule saying you need to have lived in the house for two out of the past five years in order to qualify for the exclusion. The first two are health or medical concerns and unforeseen events like natural disasters. The third is if your boss decides he’d really like you out in Ohio instead of California, even though you just bought your place six months ago.
Whatever the case, you can still exclude some of the profits made on a sale — but only some of them. If you move away for one of these reasons, you can exclude an amount of profit relative to the time you lived in the residence. For example, if you lived in California for six months and want to sell your sweet condo, you can exclude up to 25 percent (six months divided by 24 months) of the $250,000 standard exclusion, or $62,500, assuming you are a single filer.