You most likely won’t pay tax on the sale of your home unless you have gains that are more than $250,000 if you’re single, or more than $500,000 if you’re married and file a joint tax return. The Internal Revenue Service (IRS) provides a home sales exclusion that allows you to realize some significant gains on the sale of your primary residences if you meet several qualifying conditions.
Key Takeaways
- The Taxpayer Relief Act provides for a $250,000 exclusion from capital gains taxation on a home sale if you're single.
- The exclusion increases to $500,000 and you're married and file a joint tax return.
- You need only pay capital gains tax on gains that exceed the applicable amount.
- You must have owned the home for at least two of the last five years to qualify, and you must have lived in it as your primary residence for at least two of the last five years as well.
- Your time of ownership doesn't have to be concurrent with the time you lived there.
What Is the Home Sale Exclusion?
You used to have a one-time option of excluding up to $125,000 in capital gains on the sale of your home, as long as it was your primary residence and you’d reached the age of 55. That changed with the Taxpayer Relief Act (TRA) of 1997.
The TRA provides that anyone, regardless of their age, can exclude up to $250,000 in gains on the sale of a home, and a married couple filing jointly can exclude up to $500,000. This means that most people will pay no tax on the sale of their home unless they lived there for less than two out of the last five years.
Who Qualifies for Tax-Free Gains When They Sell Their Home?
You must meet the following IRS requirements to qualify for the capital gains tax exclusion on your home sale:
- The ownership test: You owned the home for at least two of the last five years.
- The residency test: You lived in the home as your main residence for at least two of the last five years.
The home must be your primary residence, not a secondary or vacation home.
Note
These rules specifically prohibit you from claiming the home sales exclusion more than once in any two-year period.
Your ownership period and residency period don’t have to be concurrent. You could rent the home and live there for two years, then purchase it and own it for the remaining three years while living elsewhere. You can use this capital gain exclusion to avoid tax on a home sale over and over, provided that you meet these rules.
How Are Gains or Losses Calculated?
You can calculate the capital gain or loss on your home by taking the original purchase price and subtracting any applicable selling costs, less the cost basis. Your cost basis is what you paid for the home plus the cost of any qualifying home improvements.
For example, you might have paid $275,000 for the property, and you spent $50,000 on allowable improvements and additions. Your cost basis then would be $325,000. Selling the home for $400,000 less commissions and fees of $5,000 would leave you with $395,000. The difference between the $395,000 and the $325,000 is your capital gain: $70,000
You won’t pay tax on this gain if you lived in the home for at least two years, owned it for at least two years, and didn’t exclude the gain from another sale in the last two years. That $70,000 falls well under the exclusion threshold, whether you’re married or single.
Note
You don’t get totake the loss as a tax deduction if you sell your home for less than what you paid for it.
If You Haven't Owned and Lived in the Home Long Enough
Any gain over the excludable amount is taxed at a rate that will be the same as your ordinary income tax rate if you owned the home for one year or less. This would be a short-term capital gain, which is taxed at the taxpayer's marginal tax rate.
Long-term capital gains tax rates would apply if you owned the home for longer than a year, and these are much kinder than ordinary income tax brackets. They depend on the amount of your overall income. As of the 2022 tax year (the return you’ll file in 2023) they are:
- 0%: Up to $41,675 if you’re single, up to $83,350 if you’re married and filing jointly, or up to $55,800 if you qualify to file as a head of household
- 15%: From $41,676 to $459,750 if you’re single, $41,676 to $258,600 if you're married filing separately, $83,351 to $517,200 if you’re married and filing jointly, or from $55,801 to $488,500 if you qualify as head of household
- 20%: Over these upper amounts for each filing status
You’ll also owe capital gains tax if you meet all these rules, but you realize gains of more than $250,000, or $500,000 if you're married and filing jointly.
Keep receipts and records of any improvements you made to the home to help reduce the total amount of your taxable gains. Certain types of home improvements can be added to your cost basis and will reduce the amount of reported gain.
Frequently Asked Questions (FAQs)
Do I have to report the sale of my house on my tax return even if I know I won't pay taxes on it?
You don't have to report the sale of your home on your tax return if you know you meet all the qualifications for the home sale exclusion. If you provide the necessary documentation to your real estate agent to prove your eligibility, they won't Form 1099 during the sale so you won't have to claim it during tax season.
Would claiming deductions help me qualify for tax-free capital gains?
Keeping track of your expenses and any capital-improvement costs can help lower the profit from the sale of your home. This can help you qualify for home sale exclusion or at least allow you to pay less if you do have to claim the sale on your taxes.
