Capital Gains and Real Estate
Before May 7, 1997, the only way you could avoid paying taxes on the profit you made from selling your home was to use that money to buy another, more expensive house within two years. After that date, due to the Taxpayer Relief Act of 1997, that is no longer the case. Also, the money does not need to be reinvested in real estate. You can use it to travel or to satisfy any need.
Nowadays, there is a real estate exemption that states that up to $250,000 in capital gains if filing single or $500,000 if filing as a married couple on the sale of the home is exempt from taxation. And this is something homeowners can repeat as many times as they want in their lifetimes. However, the following criteria must be met:
You must have lived in the home as your principal residence for two out of the last five years.
You must not have sold or exchanged another home during the two years preceding the sale.
Or you must meet what the IRS calls “unforeseen circumstances,” such as job loss, divorce, or family medical emergency.
In order to figure out exactly how much gain you obtained through the sale of your primary residence. You must do the following calculation:
You need to start with the purchase price (this is the sale price, not the amount of money you paid at closing).
Then you need to have the amount spent on total adjustments. To determine this, add the cost of the purchase such as transfer fees, attorney fees, and cost of inspections. To this number, add the cost of the sale (including inspections, attorney fees, real estate commissions and money spent to fix up the home just prior to the sale).
Adding the total purchase price and the adjustments give you the adjusted cost basis of your home. Once you subtract this number from the amount the home sold for, you get your capital gain.
One way to avoid paying capital gains is through Section 1031 of the United States Internal Revenue Code. However, to qualify for this exemption, the properties exchanged must be held for productive use in a trade or business or for investment (Personal use property will not qualify for Section 1031). The seller of the old property and the buyer of the new one must be the same, and the purchase price must be at least the same or greater than that of the property sold. Furthermore, the new property must be identified within 45 days and the purchase completed within 180 days of the sale to qualify.
As always, talk to your tax or financial advisor before selling your home to learn more about how capital gains could affect you personally.