Due to the explosive growth of population and industry in Nashville, our geographic area has been in a very bullish housing market for the last 3-5 years. This is generally good news for the local economy since this means more families are moving into an area to fill available jobs, more homes are being built, more land is being purchased for development, more people are employed in building trades, etc. However, there are other questions concerning real estate transactions that arise for people in an area that has a booming real estate market.
Likely the most common question received by financial professionals in this type of economic climate is, “the value of our home has increased greatly since we purchased, and we want to cash in on the increase in value by selling the house and unlocking the equity. What does this mean for our taxes?” This is a very good question for homeowners who are considering the sale of a personal residence. Many of you have probably heard of the concept of capital gains tax, and this is the type of tax we will be discussing in greater detail.
First off, let’s clear up the definition of a “personal residence”, as this is the most important definition to understand when considering this transaction. A house has to be your personal residence for two of the last five years preceding the date of the sale in order to gain exclusion from capital gains tax. This means that if a home is sold for a gain (profit) in 2019, all (or a portion of) that gain is non-taxable if that specific house was your primary personal residence in any full two-year period of the last five leading up to the date of sale. A personal residence is defined as “where you ordinarily live the majority of the time”, and you can only have one main residence at any time.
A married filing jointly taxpayer can exclude up to $500,000 of gain on the sale of a personal residence, and a single taxpayer can exclude up to $250,000 of gain if the following three part test is satisfied.
- Ownership– You owned the home for at least two years prior to the date of sale.
- Use– The home was your primary residence (as defined above) for at least two of the five years preceding the date of sale.
- Exclusion Period– You have not utilized an exclusion of gain for the sale of another residence within the two-year period up to the date of the sale in consideration.
If you do not meet the two year use and ownership test for the sale of your personal residence, you might still be eligible for a partial exclusion of your gain from capital gains tax treatment if one of the following is the reason for your sale:
- A change in place of employment
- Health-related move
- Unforeseen circumstances
So.. What is capital gains tax?
If for some reason you do not meet one of the exclusion tests discussed above, but still decide to sell your home, your gain will be subject to capital gains tax. The capital gains tax is a preferential rate tax that is imposed on the sale of many types of property that we normally consider “investments”. There are two types of capital gains (short-term and long-term). Short-term capital gains are considered sales of investment property held for less than one year. These gains are subject to your ordinary income tax rate. Long-term capital gains are for property held greater than one year and are given preferential rate treatment at the rates discussed below:
- 0% Rate (Single taxpayer $0-$39,375 taxable income, Married taxpayer $0-$78,750 taxable income)
- 15% Rate (Single taxpayer $39,376-$434,550 taxable income, Married taxpayer $78,751-$488,850 taxable income)
- 20% Rate (Single taxpayer $434,551+ taxable income, Married taxpayer $488,851+ taxable income)
If you sell your home and believe you are exempt from capital gains treatment on your gain, you may still receive a 1099-S form from your title company/closing agency and that form would require you to report the sale on your tax return regardless of exemption from capital gains tax implications since the IRS will also be receiving a duplicate of this form to match to your tax return!
This post covers the basics of the tax treatment of a home sale, but is not intended to cover all aspects of the tax law. As with most other tax topics, there are other exceptions/rules that apply to more complicated aspects of these transactions. It is always a good idea to maintain a client relationship with a CPA Tax Pro when engaging in this type of transaction. If you are considering this type of sale, and need CPA guidance and tax preparation services, reach out the me at wes@arcactg.com.