ABA Family Legal Guide

Buying and Selling a Home

Tax Considerations

Tax Considerations When Selling Your Home

Now I have figured my profits. What about figuring my taxes?

First, remember that if there is no profit, you do not have to worry about paying taxes; however, the IRS does not allow you to deduct any loss on a primary residence.

Until May 7, 1997, homeowners who sold their house could defer payment of capital gains tax by rolling the proceeds of the sale into a new house--but only if the new house cost more than the old one did. Then, after age fifty-five, when the homeowners were probably in a lower tax bracket and ready for a smaller home or retirement community, each person was entitled to exclude up to $125,000 in profit--but only once. Because of these rules, many families bought bigger, more-expensive houses than they needed, especially if they moved to an area with lower real estate values.

All this changed in 1997 with a new tax law. Now you do not have to pay capital gains on the sale of any residence you have lived in for at least two of the last five years, unless the profit is more than $250,000 per person or $500,000 per couple. You have to count not only the profit on this house but on any other houses you sheltered by rollover prior to 1997. If special circumstances meant you had to move before living there two years, you can exclude part of the profit--for instance, half the profit if you lived there only one year, up to your $250,000 limit.

This change means that most people won't have to pay capital gains taxes at all on their home, unless they have enjoyed a very substantial profit. And you can exclude this capital gain on the sale of your residence as many times as you sell another primary residence meeting the two-year test. Note that this door does not swing both ways. If you lose money on the sale of your home, you cannot deduct the loss and pay less in taxes or carry the loss forward.

The capital gains exclusion does not apply to investment properties and vacation homes. However, people with more than one home can avoid tax on each of them with enough planning. For instance, if you have a condo in New York City and a house in Florida , you could live in the New York home as your primary residence for two years before selling it, then live in the one in Florida as your primary residence for two years before selling it. For a house to count as your primary residence, you have to live there for at least 183 days each year.

Win or lose, whenever you sell a home you have to file Form 2119, reporting the sale date, the price, and how much profit is subject to immediate taxation, if any. This one-page form takes you through the calculations required to determine gain on sale, adjusted sales price, and taxable gain. If you die without selling the home, all capital gains taxes are wiped off the slate. Your beneficiaries will inherit it at a new, stepped-up basis, and they will not have to pay any tax on capital gains accumulated on the sale of your home or homes over the years.

What if you own a duplex, live in one unit, and rent out the other? In that case, you can only avoid capital gain on the half you use as your residence. The other is a business property, not subject to this tax break.

For details on IRS regulations in this area, see Publication 523, "Selling Your Home."