There are countless reasons that will lead to you selling your home: a new job, starting a family, or maybe the family is all moved out and it is time to downsize. Whatever the situation, to report the sale of your home is something that many taxpayers struggle with and stress over. Having the proper knowledge of things you need to do when the time comes is very important and can help you avoid (1) having to recognize a massive gain and (2) pay a hefty tax liability.
Consider the following tips and tricks when you are selling your home:
1) Keeping good records of your home
Keeping records of the closing statement and all improvements to your home is essential. If you file your own taxes, this will save countless hours of your time. Or, if you are working with a tax professional, it will keep them very happy (and not constantly hounding you to answer questions about the house). Having this documentation is the best way to calculate the basis of your home. Simply put, the basis of your home is what you paid for it plus any significant improvements.
Some examples of significant home improvements to document are:
- A kitchen
- Replacing insulation
- Extensive landscaping
- Building a new deck
2) Calculating the basis for your home
Basis = purchase price + significant improvements + certain closing costs – home office depreciation – casualty losses claimed
The sale of your home will be reported on Schedule D of your tax return. In short, you as the homeowner will report the dates the home was purchased and sold, along with the sales price and your basis in the home. The sales price will just be the amount listed on the closing statement. The basis calculation is what takes some time, which is why it is important to keep good records. Having the closing statement from the original purchase of the home is a good starting point. From there, add all significant home improvements that have been made. There are also certain closing costs (on the closing statement from the sale) that can be added to your basis. These include escrow fees, title charges, recording fees, seller credits, and commissions.
The next part of the basis calculation is what should be subtracted. There are some reasons why the basis in your home would decrease. For example, if you report a home office, the depreciation taken for the area of your home in which the office is located will reduce basis. Also, if your home was damaged due to a natural disaster or theft, any loss (casualty) reported on Form 4684 will reduce basis.
3) Avoid recognizing gain
With the housing market in its current state, it is likely that your home will sell for much more than its purchase price. When this occurs, a capital gain will arise. To calculate the gain (or loss) when you sell your home, you will subtract the basis calculated in the previous section from the sales price. Fortunately enough, there are many ways to exclude a large amount of gain and hopefully none of the gain will be taxable.
As long as you have lived in your house for two years, or for two out of the last five years, you will qualify for a gain exclusion of $250,000 ($500,000 if married filing jointly).
A reduced exclusion may still be allowed, even if you didn’t live in the house for two years, due to unforeseen circumstances. Some potential reasons could be change of employment, health concerns, divorce, and more.
Note: Expenses regarding the sale of your house will reduce the gain on the sale. Some examples of these include attorney fees, closing costs, recording and transfer fees, loan origination fees, and utility service installation.
Also note: Although it is unlikely that a loss will arise when you sell your house, losses on the sale of your home are not tax deductible.
Keeping sufficient records will help you reduce stress when the time comes to sell your home. Keeping these records will not only help you accurately calculate the basis in your home, but along with the rules that the IRS has place, could end up saving you quite a bit of money.
To learn more about this topic contact Origin CPA Group today.