Whether you are moving into a bigger home after outgrowing your starter home or downsizing, selling your home in Charlottesville VA is just as major a life decision as buying a new home. Selling the place you’ve called home for many years is a huge deal, especially when you start figuring out the taxes involved in a home sale.
If you are selling a home for the first time, you probably are wondering if you have to pay taxes on the sale of your home. Knowing how much taxes you need to pay—if there’s any—is important when selling a home because it will impact your finances for the many years to come.
In this article, you will discover everything you need to know about the taxes on selling a house, including tax breaks, reduced exclusions, reporting your home sale on a tax return, and determining the total profit of your home sale.
When you sell your home, you may be required to pay taxes on the money you earn from the sale. The good news, however, is that there are certain exceptions that may result in you paying very little or no tax at all.
Read on if you want to know if you owe taxes on the sale of your home.
Are You Required to Pay Taxes When Selling Your Home in Charlottesville VA?
As I said, there’s a chance you will have to pay taxes out of the money you earn from your home sale after you’ve sold your home. However, there’s also a chance for you to pay very little or nothing at all.
If you have lived in your home for two of the five years directly before you decided to sell it, the first $250,000 of whatever profit you make on the home sale is free of tax. This amount increases to $500,000 if you are married and you and your spouse file a joint tax return.
Note, however, that what we are talking about here is the first $250,000 (or $500,000) of the profit you make and not the income, so that means the tax is based on what you gain from the home sale and not on the total amount of money you make from the home sale.
There’ll be quite a bit of difference if you sell your Charlottesville golf home for less than $250,000 more than you purchased it for and if you’ve lived there for at least two of the previous five years. In that case, you don’t owe any taxes on your home sale.
How do you determine the profit on your home sale?
Now that you know when you need to pay taxes on your home sale, the next question is how do you determine the profit you make from selling your home? Remember, calculating your profit is necessary to determine if you owe taxes on your home sale. It may sound easy as pie, but calculating profit from a home sale is not as simple as subtracting the price paid from the sale price.
To determine your profit, the first thing you need to do is to figure out the cost basis for your home. As you do this, consider not only the total amount that you spent when you bought your home but also the amount you spent on renovations and improvements. If you spent an additional $20,000 when you added an extra room, then you need to add $20,000 to your cost basis.
Once you’ve calculated that, the next thing to take note of is how much you sold your home for. To get that amount, you need to deduct all the fees you paid, including the closing costs and realtor fees when you sold it. That means if you sold your home for $300,000 and paid $10,000 in closing costs and realtor fees, then the amount you earned on your home sale should be $290,000.
Now that you know how much you earned from your home sale, the next thing to do is to subtract your cost basis from this amount. In our example, your profit is $70,000 because that’s the result you get when you subtract $220,000 from $290,000.
Based on the rule, if the amount is less than $250,000, you won’t owe any taxes on your home sale. In this case, $70,000 is less than $250,000, so there is no need for you to pay taxes on your home sale.
How do you qualify for home selling tax breaks?
If we look at the example above, it may look like it’s so easy to sell a home and not to have to pay taxes at all. Actually, there are three basic requirements you need to meet if you want to qualify for the above tax break. Only when you meet these three qualifications will you be eligible for the tax break. Here are the requirements:
· You must have been the owner of the home you are selling for at least two years. If you’ve been the owner of that home for less than that, then you cannot qualify for the tax break.
· The home you are selling must have been your primary residence for at least two of the past five years. This is the reason why vacation homes and rental properties usually don’t qualify for tax breaks.
· You must not have used this tax break for the sale of another home within the past two years. Tax breaks can only apply to one property, so it doesn’t really matter if you are selling multiple properties at the same time.
How do you qualify for a reduced exclusion?
If you don’t meet all of the requirements to qualify for home selling tax breaks, there’s still hope. Through a reduced exclusion, you still get to claim part of the tax break even if you are not totally eligible for the tax break. For instance, if the requirement is that you’ve lived for at least two years in the house you’re selling but you’ve only lived in your home for one year, you could still be exempt—but only for $125,000 of any profit you make from your home sale.
It isn’t that easy to qualify for a reduced exclusion though. To qualify for this benefit, you need to present a valid reason for not being qualified for the tax break. Examples of valid reasons include employment change, health reasons, or any unforeseen circumstance that leaves you with no other choice but to put your home on the market sooner than expected.
How do you report the sale on your tax return?
Unless you assure your real estate closing company that you will not owe taxes on your profit, you will receive a Form 1099-S when you make your home sale. Here is where you will report your home sale. If you happen to receive this form even when you are qualified for the tax exemption, you’ll need to report your home sale even if it doesn’t necessarily mean you owe taxes. Any profit that goes above or does not qualify for the exemption is taxed as a capital gain.
So how do you avoid capital gains tax on your home sale?
Considering the factors needed to qualify for a tax break, here are the three important things you need to do to avoid having to pay taxes on your home sale:
1. Live in your home for at least two years before selling it
This is easy to do, since the two years don’t necessarily have to be consecutive. Selling in less than a year will cost you a lot because you could be subject to the short-term capital gains tax, which is higher than the long-term capital gains tax.
2. Verify whether you actually qualify for an exception.
If you have a taxable gain on the sale of your home, you can still exclude some of it if you have a valid reason for selling your home sooner than anticipated.
3. Keep all the receipts for your home improvements.
Remember that the cost basis of your home does not only include what you paid to buy it, but also the improvements you have made over the years. The higher your cost basis is, the lower your exposure to the capital gains tax is. Examples of things that can cut your capital gains tax are remodels, new windows, new driveways, air conditioning installs, expansions, etc.
In conclusion, the question of whether or not you need to pay taxes on the sale of your home depends on your qualifications. While it’s possible you’ll need to pay taxes on your home sale, chances are you won’t have to, if you meet all the three requirements we’ve discussed.
By meeting just a few simple requirements, you can get up to $250,000 of your profit from your home sale tax-free, and this can even jump to $500,000 if you and your spouse file jointly.
Please be sure to check with your financial advisor, CPA or tax consultant to see how the sale of your home best fits in with your financial plan and what tax benefits you may qualify for.
If you are selling your home in Charlottesville VA and you need someone to assist you with your home sale, call me, Pam Dent, at 434-960-0161 today.