Hi Folks:
My wife and I bought a new home 6 years ago, but we decided to retain the home we had been living in as a 2nd home. Finally, after living primarily in the new home for 6 years we decided to sell the other home. In fact we sold it last week. My questions are: Will the IRS consider the money we received from the sale of the home as income? Will the money from the sale be subject to income tax?
I appreciate any assistance that will help answer my questions.
Sevenz
The following assumes that the old home ceased to be your main home six years ago and it was not a rental property (or the like) during this time.
The sale of the home will be income, but only the capital gain (profit) will be subject to tax. Generally, that means take the amount you sell the house for (minus sales expenses) and subtract what your basis (what you bought it for) and the difference will be your capital gain or loss. Since you owned it more than one year, it will be a long-term capital gain (maximum 15% federal rate plus state rate). Unfortunately, since it was for personal use, you cannot claim a capital loss.
Your “basis” starts out being the amount you paid for the house, but there can be adjustments. For example, if you made any capital improvements to the house (added a swimming pool or garage), those can be added to your basis. If you took casualty deductions, home-office deductions, rental depreciation, etc, those are subtracted from your basis.
Since the house was not your main home for at least two of the last five years, you cannot take the $250,000/$500,000 main home exclusion.
In addition to any federal income taxes, state and local income taxes may apply.
I suggest you cuddle up with a copy of Publication 523 (pdf). It should address most of your questions.
(Assumption: You are in the US)
IANA Tax Professional, but I would think that at most you will be liable for capital gains taxes on the difference between the cost of the house (including purchase price and cost of improvements, but not repairs) and the sale price (less commissions and other sales costs). Primary homes are treated specially for the purpose of capital gains (I think there’s some lifetime exclusion). I’m not certain about second homes. Things are more complicated if the second home generated income (through rental), since you likely would have taken depreciation on it, thus lowering the basis.
When I have questions like this for myself, I play “what-if” games with TurboTax. It will walk you through the forms and laws applying to most common situations, at least for the most recent tax year.
ETA: What Alley Dweller said. I type too slowly.
Any gain on the home could be subject to capital gains tax. Gain is your sale proceeds less your basis (purchase price and improvements for most people). A 1099-S reports the sale price; it’s up to you to report the additional information on your tax return.
Sec 121 can exclude gain from taxation for the sale of a residence. The rules have been updated for homes with mixed use, so review them to see if there’s a benefit available.
Thank you very much, Alley Dweller.
This brings up an interesting question: Suppose that instead of us keeping the house for a 2nd home, we had sold it first and then used the money to help purchase the new home? Would the sale of the home then be income?
Thanks for the help.
Sevenz
If you had owned the home and lived in it as your main home for 2 of the 5 years before you sold it, you could claim the the Sec 121 exclusion that dracoi mentioned above. If you both lived in it and you filed a joint return, the first $500,000 of gains would be tax-free. (If you lived there less than 2 years and moved for a qualified reason, you could take a partial exclusion, see Publication 523 (pdf).)
And it wouldn’t matter if you bought a new home or not. You could take the money to Vegas and put it all on red and you would still get the exclusion. Up until 1997 there was a rule that you could defer (not eliminate) tax on your capital gains by buying a new house. But that was replaced by the Section 121 exclusion.
Instead of “an interesting question”, it was actually a dumb question – it just took me a little while to realize it. LOL Yes, the sale of a house is still a sale, no matter whether it was last week or 6 years ago. Duh! LOL
We bought the 1st house way back in 1968. I invested tons of my spare time and a lot of money into remodeling the place over the years. For example, I personally paneled the walls in most of the rooms; tiled the ceilings; replaced all the windows with new storm windows; replaced the exterior doors and installed storm doors; replaced all light fixtures, electrical outlets and switches. Then in 1992 we hired a contractor to bump out the bathroom wall and enlarge the bathroom, and totally refurbish it with a new pedestal sink, toilet, tub/shower, and new custom cabinets. We also had a contractor build custom cabinets for the kitchen, plus give the kitchen a complete makeover.
The main reason we (mainly me) kept the house for so long after buying the new one was because we had so much of ourselves tied up in the old place. But I’m in my 70’s now, and it’s gotten to be too much for me to take care of.
Thanks again, everyone.
Sevenz
We prefer that real life legal/medical/tax etc. questions go in IMHO rather than General Questions. Moved.
samclem, moderator
Thanks, Mod.
No, assuming you’d lived in it for a specific length of time (2 years?). As a married couple you’d then be entitled to exclude up to 500,000 dollars from income for capital gains purposes.
There are some situations which allow you to take a partial exclusion if you lived there less than 2 years - e.g. moved because of medical or job reasons. But if you just moved in less than 2 years because you felt like it, then the whole profit would be taxable.
At least the gain would be viewed as long-term (lower tax rate).
In hindsight, if you could go back in time you might have been able to save on taxes if you’d returned to using the old home as your primary residence; that would have involved using that for your driver’s licenses, taxes etc. so you had evidence of this.
A side question - it seems from the responses that there’s no allowance for inflation, the capital gain is measured as the difference between the buy and sell prices. Is that correct?
While it’s not going to be too big a deal for the OP it seems hideously unfair to me if that’s the case when the taxpayer has owned the property for many years. Or is this what the lower long term rate Mama Zappa mentions is intended to ameliorate?
(I’m from a land with no capital gains tax at all - which creates it’s own unfairnesses and distortions).
Yes, most simply put the capital gain is the difference between the two prices; really though, any improvements you’ve made along the way are added on to the purchase price. Say you bought for 100,000, spent 50,000 adding a new room, then sell for 210,000; your profit is 60,000 (210,000 - 150,000), not 110,000. I think another poster described this upthread.
Long-term gains are taxed at a lower rate even if your other income is high; this was something pushed through our tax laws 20ish (?) years ago. It’s why some extremely rich people have lower effective tax rates than some less-rich: earned income could be taxed at up to 35% (I think).
The same rate applies to any kind of gain, whether it’s from selling a house, or selling stock. If you’ve held the stock for over a year it maxes out at 15%, if you’ve held it for 364 days you could pay quite a bit more.
Inflation: yeah, but realistically because of the law that says “first half a million doesn’t count”, even a long-held home is rarely going to increase that much unless it’s in an area that really took off. That is, as long as that home was your primary residence. Second homes, investment properties, vacation homes, no such luck and that’s where the OP will run into a tax hit. When my mother’s house was sold, it went for about 8 times their purchase price after 40+ years, but that was still well less than the 500,000.
So if the OP sells a house that they put 100,000 into (purchase and improvements; sweat equity doesn’t count as far as I know), and they sell for 500,000 now, that’s a 400,000 gain. Max tax rate is 15% which would be 60,000 because it’s long-term.
Thanks for that - is the first $500,000 exemption only for homes? Or does it cover all capital gains?