If you’re thinking of selling your Boca Raton home, you probably already know that a $250,000 profit on the sale of the home will not be subjected to capital gains taxes.
But it seems far less well known that up to $500,000 is exempt from taxes if you are a married couple filing taxes jointly.
For this exclusion to apply, you need to show (in case the IRS comes calling) that both you and your spouse have owned – and, more importantly – lived in the home for at least 2 of the 5 years prior to the sale.
The days do not have to be consecutive, but they must add up to at least 2 years (730 days). This pleasant tax consequence (or perhaps non-consequence is a better term) applies to you if you purchased your present dwelling anytime after May 6, 1997.
This can be more than a once-in-a-lifetime experience.
What’s even more appealing about this aspect of our usually confusing tax code is that this is not limited to a once in a homeowner’s life time experience.
So if you are of the mind to find and flip your dwelling – and cope with the aggravation of moving, – then you can take advantage of this happy tax break every 2 years. But you must be able to show that this was your full time residence during that 2 year interval.
It only applies to your primary residence.
While the mortgage tax incentive applies to primary and secondary homes, the capital gains avoidance applies only to your primary residence. If you attempt to avoid paying a capital gain on the sale of a second residence within that 2 year period, Uncle Sam is likely to get very upset with you.
Your primary residence is defined as the one you and your immediate family members – spouse and children – spend the most time in. Easy ways to determine primary residence include proximity to your workplace, district where you’re registered to vote, where your children attend school, and (an unofficial test) where you buy most of your groceries.
The difference between original price and selling price may not be the profit.
A common mistake most of us make is taking the difference between the original purchase price and the selling price and presuming that sum is the profit.
So, for example, let’s say you and your spouse bought a home in 2001 for $150,000. Thanks to inflation and the lack of inventory in the area, you’ve just closed at $750,000. That appears to be a difference of $600,000 between your original purchase price and your current sales price. So you and your spouse figure you’ve got a profit, and thus a capital gain, of $600,000.
Even if you show that much of a gain, you don’t owe that entire sum. You owe only the percentage of the profit that your tax bracket (and your accountant or qualified tax professional) tells you is due.
Profit is based on improvements and up front purchase costs.
However, and this is very important, the profit you make on your home is determined by the improvements you may have made to your house during the time you lived in it. You get to deduct the cost of that new kitchen and the new bathrooms and the new wood floors and the addition you made to the master bedroom and the new roof you had to put on. (Why do you think the new buyers didn’t mind paying you $750,000?)
Your profit is also determined by your closing costs, including realtor commissions and title fees.
What you also probably did not figure into the equation was that your original purchase price, plus the original expenses involved in the purchase are part of your actual cost basis. So that $150,000 base probably had title fees, advance taxes, mortgage points, and some legal fees attached.
Using those examples, let’s say all of the above-mentioned home improvements came to $150,000. That brings your gain down from $600,000 to $450,000. Then let’s say there was another $10,000 spent when you first purchased. That brings your profit down to $440,000.
And that means you and your spouse have no capital gain to contend with. The profit on the house is yours to use as you wish, with no tax consequence, because it is under the limit for a married couple filing jointly.
Possible exemptions above $500,000
This time, let’s say your $150,000 house sells for $900,000 and there are no improvements to deduct. But – you happen to be an extended family so your son purchased the home along with you. And you’ve all lived there happily for the last 2 years. He married a year ago and he and his wife remained in the house.
Well, interestingly enough, you may still escape the capital gain. That is because you and your wife are eligible for the $500,000 exemption. And your son, whose name is also on the deed, is eligible for a $250,000 exemption because this has also been his principal residence for the last 2 years.
Let’s carry it one step further.
The gain on the house is $1 million dollars. Unhappily for this extended family, your son’s wife has lived in the house for only 1 year, so she is not eligible for the full $250,000.
But because she is half of a married couple filing jointly, she can claim half of that amount when the house is sold. So on this $1 million profit, you will jointly be responsible for $125,000 in capital gains at your tax rate.
A possible exception to the 2 year rule
Occasionally we run into unexpected problems in our lives. When dealing with the capital gains on the sale of your home, these events are referred to as “unforeseen circumstances.”
A divorce. An illness. Changing to a job that necessitates a move of 50 miles or more from your present residence. The death of a family member. These are aspects of life that you can’t plan for.
If any of these things happen to you, even if you have not occupied the house for the full two years, you may still be eligible to claim a percentage of the capital gains exclusion, based on the number of months you have lived there.
By the way, although you can be responsible for a capital gain on the sale of a house, Uncle Sam will not compensate your for a capital loss on that sale.
Thinking of selling your Boca Raton home?
Let our professional real estate team help you get it sold. Call us at 561-213-6139 to talk about your home’s value. It may be worth more than the figure you have in mind.
Marc Jablon, the Jablon Team
Re/Max Complete Solutions
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