Many homeowners that are selling their home have no idea what tax ramifications exist. As a tax professional, this is where you can come into play. You can help your clients consider what the tax consequences of selling their home would be. In the end, if it turns out that they will owe a large amount of money in taxes, they may reconsider selling their home or take whatever steps necessary to reduce their tax liability. Be sure to help them determine their capital gains or loss, tell them about the consequences and exemptions of capital gains and inform them of any further development, such as legislation, affecting the tax ramifications as they present themselves.
Determining Capital Gains or Loss
To determine the gain or loss on the sale of your clients main home, you need to know the selling price, the amount realized, and the adjusted basis. You subtract the adjusted basis from the amount realized to get their gain or loss from selling their home.
· Selling Price: The total amount your client receives for their home (includes money, all notes, mortgages or other debts assumed by the buyer as part of the sale)
· Amount Realized: The selling price minus selling expenses
o Selling expenses include: commissions, advertising fees, legal fees and loan charges paid by the seller
· Adjusted Basis: While your client owned their home, they may have made adjustments to the basis. These may include both increases and decreases.
o Increases to their basis may include: Capital improvement made to the home that add value, prolong the condition of the home, or give it a different function. Examples: remodeling the home or parts of the home or adding a swimming pool, etc.
o Decreases to their basis may include: Any depreciation, energy credits or damage, destruction or loss of your property from any sudden, unexpected, or unusual event claimed to reduce taxes while you client owned the home are considered decreases to their basis.
Capital loss on personal residence is not tax deductible. If your client has a capital loss on the sale of their home, they will not be able to write that loss off against other income.
Long Term Capital Gains
If your client makes a profit on the sale of their home, they may need to report the profit as a capital gain when they file their taxes. However, if they owned and lived in the home as their main home for at least 2 out of the past 5 years, they may be able to exclude up $250,000 of the gain if they are single and $500,000 for married couples filing jointly.
Tip: Per the IRS Publication 523, “The required 2 years of ownership and use during the 5-year period ending on the date of the sale do not have to be continuous nor do they have to occur at the same time. You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days (365 × 2) during the 5-year period ending on the date of sale.”
Note: If your client is eligible to exclude the gain, they do not need to report the sale on their tax return unless they receive a Form 1099-S, Proceeds from Real Estate Transactions.
Short Term Capital Gains
If your client lived and owned the current property, they are considering selling for less than two years, they still may be able to claim part of the capital gain exclusions. There are three exceptions to the capital gains rule, and the amount your client is able to exclude is determined by a formula based on the amount of time they actually lived in the home. The three exceptions to the rule are as follows:
· Your client was forced to move because of health concerns. Exceptions include:
o Selling home to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of a disease, illness, or injury of a qualified individual
o Selling home to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness of injury.
· You client is moving due to employment reasons. For this to be considered, it must meet the following criteria:
o The change of employment occurred during the period your client owned and used the property as their main home.
o The new place of employment is at least 50 miles farther from the home they sold than was the former place of employment. If there is no former place of employment, the distance between new place of employment and the home sold is at least 50 miles.
· Your client is moving because of unforeseen events. Examples of unforeseen circumstances that apply are:
o Home is destroyed or condemned
o Natural or man-made disasters
The IRS has created a page on IRS.gov for information about Publication 523. Any further development affecting Publication 523 (such as legislation) for 2012 will be posted to that page.