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.