Question about Excluding the Gain from Sale of Home

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bUU
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Question about Excluding the Gain from Sale of Home

Post by bUU »

I've read it over and just want some clarity. It seems very straightforward to me: If you live in a home you own for two years, and you have a $250K gain on the home, the gain isn't taxed. And you can do that every two years? For some reason I thought the exclusion was a one-time thing. Can someone confirm my understanding?
kaneohe
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Re: Question about Excluding the Gain from Sale of Home

Post by kaneohe »

http://www.irs.gov/taxtopics/tc701.html

I think your understanding is the same as mine.
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jimb_fromATL
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Re: Question about Excluding the Gain from Sale of Home

Post by jimb_fromATL »

Yep. If you've lived in it for two out the last five years as your principal residence before you sell it, you can exclude the first $250K (single) or $500K (married filing jointly) of gain from capital gains tax. And you can do the same with your next home. The old rule about buying another home no longer exists, either.

HERE is the IRS publication that goes into detail.

By the way a common misunderstanding worth mentioning is the amount that counts as gain that might be taxed. That amount may not be very related to the amount you receive from the sale or how much (if any) you walk out with from closing on the sale. It's the gain that counts, not the amount of money that you may or may not have left after closing on the sale.

The capital gain is the difference between your cost basis (which is essentially what you paid for it plus any capital improvements you made to it) and the amount realized from the sale (which is the sale price minus the sales expenses). Then the $250K or $500K exclusion is subtracted from that.

Here are some simplified examples for illustration:

If you paid $50,000 for a home originally a long time ago and did $10,000 in capital improvements (as defined by the IRS) your cost basis would be $60,000. If you could sell it for $270,000 and had to pay $20,000 in commissions and expenses for the sale, then the amount realized from the sale is $250,000.

Since you realize $250,000 after the sales expenses, your gain is only 250000 - 60000 = $190,000.

However, if you had refinanced it for cash out and owed a $100,000 balance on the mortgage you'd have $150,000 clear at closing after paying it off.

In this example you have a gain of $190,000 even though you only cleared $150,000 on the sale after paying off the mortgage. But assuming you've lived in it two out of the last five years, none of it is taxable since it's less than $250K.

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If you could sell a home for $195,000 and had to pay $20,000 costs to sell it, the amount realized from the sale is $175,000. If you owed only a $25,000 balance you'd have $150,000 clear after paying it off. If you paid $50,000 for it originally and made $10,000 in capital improvements, your cost basis would be $60,000. Since you realize $175,000 after sales expenses, the gain is 175000 - 60000 = $115,000 even though you cleared $150,000 on the sale after paying off the mortgage. Again it would not be taxed if you meet the two out of five year rule.

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Suppose you were single living in California or the Northeast in an expensive home. If the original price was $750,000 and there were $22,500 in capital improvements. The cost basis would be $772,500.

If it appreciated at an average of 5.% per year for 10 years and you sold for $1,221,671, then with 7% sales costs of $85,517, the amount realized would be $1,136,154. So the gain is 1136154 - 772500 = $363,654. After subtracting the $250,000 exclusion for a single person, the taxable gain subject to tax would be $113,654.

The federal tax, assuming you'd be in the 15% cap gains bracket, would be $17,048. If the state tax on the gain were 9.3% that would be another $10,570.

For a married couple, there wouldn't be any tax.
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jimb
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bUU
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Re: Question about Excluding the Gain from Sale of Home

Post by bUU »

Thanks!

If I understand correctly, we're golden: The amount we're selling it for is less than $250K more than the purchase price. If I understand correctly, the two adjustments you mentioned would just make the calculation go even further in our favor.
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ResearchMed
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Re: Question about Excluding the Gain from Sale of Home

Post by ResearchMed »

bUU wrote:Thanks!

If I understand correctly, we're golden: The amount we're selling it for is less than $250K more than the purchase price. If I understand correctly, the two adjustments you mentioned would just make the calculation go even further in our favor.
You mention "we". If the "we" is a married couple, then it's $500k free and clear, using the same calculations.
It doesn't sound like that would be relevant here, but in the future... who knows? :happy [Assuming tax laws remain the same for this.]

If the current case, yes, it would have allowed you "more" IF there had been other money put in, or selling costs, etc.
But if the "obvious difference" (selling price minus purchase price) is less than $250k ($500k married), then there's no need to dig up all the records to document other expenses along the way.

RM
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Wagnerjb
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Re: Question about Excluding the Gain from Sale of Home

Post by Wagnerjb »

jimb_fromATL wrote: The capital gain is the difference between your cost basis (which is essentially what you paid for it plus any capital improvements you made to it) and the amount realized from the sale (which is the sale price minus the sales expenses). Then the $250K or $500K exclusion is subtracted from that.

jimb
If you lived in the house for the past dozen years and you sold for a gain of $100,000 (before capital improvements), then I assume you don't need to keep records of any capital improvements. Right? If the gross gain is only $100,000 then I don't see how it would pose any risk to dispose of such capital improvement records. (Of course you may want to give a copy of those records to the buyer of the house, but I see no need to retain for IRS audit concerns).

Best wishes.
Andy
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