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Capital Gains Tax and the Sale of Your Home

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    Even profits made upon the sale of your home could result in tax consequences. Capital gains tax treatment concerns profits made upon the sale of specific assets and such treatment could involve the sale of your home that you owned for several decades.

    Capital Gains

    The triggering of capital gains tax treatment does not occur in every sale, however. Federal law makes such a tax applicable to a qualifying primary residence where profits exceed a minimum amount. That minimum amount is $250,000 for individual homeowners and $500,000 for spouses who own a home. In other words, the sale of the home must exceed the amount of the initial price of the home by these amounts for capital gains tax treatment to apply.

    Please keep in mind that the above minimum amounts only applies to the primary residence. If a homeowner sells a home that is not the primary residence, they will not be able to use these minimum amounts to shelter this income from capital gains treatment. The above minimum amounts will also not apply for the sale of investment properties, or if you have not claimed the home as your primary residence for a minimum of two of the past five years.

    Liabilities

    There are ways of reducing your tax liability. For example, you may be able to subtract the amount paid for home improvements from the profits you earn upon the sale of your residence. It is, therefore, a good idea to keep accurate records on file regarding home improvements made while you lived at the residence. You may also be able to deduct other expenses as well including prepaid interest on the mortgage, title insurance, real estate commissions, and certain administrative costs.

    What Are the Tax Consequences?

    This question comes up in many contexts. Moving for job may require you to sell your primary residence before having a down payment for a new home. It may be time to downsize and sell a vacation home. After the loss of a parent, you may need to sell a home.

    Mistakes could leave you with a significant tax bill you may not be able to pay. This blog will cover some other basic tax considerations related to selling a home.

    In any of the following scenarios, it is important to keep documentation on improvements. The costs of a kitchen remodel or addition to the home can be added to the basis when calculating your tax bill.

    Here is how it works. You purchased a property for $250,000 and make $50,000 of improvements over several decades or ownership. Your basis in the property would be $300,000. If you sell the property for $450,000, a couple factors will affect your tax bill.

    Was this a primary residence?

    You can exempt up to $250,000 of profit on the sale of a primary residence. A couple would not owe taxes unless they earned more than $500,000 on the sale.

    There is a test for whether a home qualifies as a primary residence. You must be able to prove that the home was your main residence for at least two of the last five years leading up to the sale. In our scenario, you would not owe any taxes, because the gain was $150,000.

    Second homes, vacation properties and investment properties

    Whenever you make money on the sale of one of these properties it is treated as capital gains. This is where you really want to track improvements. The taxable amount in our example is $150,000 rather than $200,000.

    Because of the difference in tax bill, the IRS closely scrutinizes gains from the sale of a property and may audit your return

    Failing to have the right support for classifying your property as a primary residence could result in a hefty tax bill. If a sale already occurred and now the IRS is asking questions, speak with a tax attorney. 

    What should a taxpayer do?

    The amount of taxes Michigan residents owe may revolve around a number of other complex tax factors as well. If you are in a lower tax bracket, there may be a reduction in your capital gains tax rate. Your marital circumstances can impact the taxes you owe. There may also be exemptions for military personnel regarding the two-year residency requirements.

    Because the rules are so complex, the IRS may not always agree with the manner in which you report such gains. It, therefore, may be extremely helpful to seek legal advice regarding such matters to prevent reporting issues from arising.

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