Homeownership is still considered as one of the American dream as most of us really wants to have a piece of America. Aside for the emotional benefit of homeownership, it has a built in various financial benefits that you can never achieve if you are just renting. One of the most common financial benefit are the tax breaks that the government provide such as being able to deduct various home related expenses such as the home interest, real estate property taxes, qualified mortgage insurance premium. In addition, when a homeowner sells his/her house, he/she can exclude up to $250,000 ($500,000 for married joint filers) of the gain on the sale of the home from his/her taxable income.
Because of the most recent downturn in real estate, people who have just bought their homes recently may not really see a big increase in equity, if any, since the home appreciation have been stagnant lately. So if you are planning on selling your home nowadays and you have just bought your home a couple of years ago, you probably won’t see huge gains but you may potentially see losses. People who have purchased their homes before the real estate bubble and experience huge gains may be able to enjoy this very generous tax break. If the tax break does not exist, you would need to pay as much as $50,000 in taxes ($100,000 for married joint filers) depending on the gain and your tax bracket or tax rate.
Exclusion From Income on The Gain
Homeowners who sold their home in 2010 may be able to exclude up to $250,000 ($500,000 for married joint filers) of the gain from their taxable income. The rule is the home must be your principal residence for 2 out of the last 5 years from the date that you sold your home.
Calculating Your Gain or Loss
The gain or loss from the sale of your home is calculated as follows:
Selling Price – Selling expenses – Adjusted basis of your home = gain (loss) on the sale
Selling expenses - the most common selling expenses are real estate broker/agent’s commission, market listing fees, legal fees, loan charges paid by the seller, escrow fees, fees for drafting a contract of sale and deed, geographical survey maps, recording fees, and expenses paid for transferring the title (abstract, certificate, opinion, registration) etc.
Adjusted Basis – In general, the adjusted basis of your home is equivalent to the price you paid when you purchase your home plus any other improvements you made on your home. Improvements are any expenses you incurred that adds value to your home and have a useful life of more than 1 year. Examples of these are replacing your roof, remodeling your kitchen or bathroom, adding a new bedroom, extending your patio to add a living room, replacing your old electrical wiring, replacing your plumbing system, putting up a new fence, paving your unpaved driveway or backyard, etc. However, any expenses incurred for repairs such as fixing the leak, replacing broken windows, or repainting the inside or outside of your homes do not add to the basis of your home.
- For example, if you bought your home for $200,000 and you remodeled your kitchen for $10,000 and added a bedroom for $20,000, and made a total of $15,000 in repairs throughout the years, the adjusted basis of your home is only $230,000 ($200,000 + $10,000 + 20,000), which excludes the total paid for repairs.
While the gain on the sale of your principal residence may not be taxable, the loss on the sale of your home cannot be deducted from your tax return!
How to Qualify for Exclusion
In general, you can exclude the gain on the sale of your home for up to a maximum of $250,000 if during the past five years period ending on the date of the sale, you owned the home AND it must be your principal residence for at least two years. Short temporary absences for vacations or other seasonal absences, even if you rented out the property during those times, counts toward the principal residency requirement. In addition, you can only exclude the gain on your current house if you did not exclude gain from sale of another home during the 2-year period ending on the date of the sale. In this way, those people who are flipping houses for a short period of time will not qualify.
- Example 1: You bought your first home for $100,000 on July 15, 1998. In 2005, you bought a second home and decided to have your parents live in your first home for free. However, during the real estate bubble, you couldn’t pay both mortgages and you ended up foreclosing your second home (bought in 2005) in 2007. You decided to go back in your first home on October 31, 2007. On January 15, 2010, you sold your first home for $400,000 and recognized a gain of $250,000 (after accounting for everything such as home improvements and selling expenses). You can exclude the $250,000 gain on your income because the house is your principal residence and you own the house for 2 out of the 5 years from the date your home was sold.
- Example 2: Same scenario as above but instead of having your parents live for free, you actually have it rented to someone else. You can exclude up to $250,000 on your return but you cannot exclude the part of the gain equal to the depreciation that you claimed or could have claimed for renting the house. For example, if your total gain on the home is $250,000 but $20,000 of those is attributed to the depreciation of a rental home, then you can only exclude $230,000 on your income and you have to pay taxes on the $20,000.
If you and your spouse are filing your return jointly for the year of the sale, you can exclude as much as $500,000 of the gain on the sale of your home for as long as the house is the principal residence of both you and your spouse for 2 out of the 5 years and at least one of you own the house for 2 out of the 5 years. However, if the house is the principal residence of only one spouse, then you can only claim as much as $250,000 even if both of you owns the house (both of your names are on the title).
- Example 1 - You bought your home for $150,000 in 2000 when you were still single. On December 31, 2007, you got married and your spouse moved in with you a month later. You never put your spouse on the title of the home. On February15, 2010, you sold your home for $700,000 and you recognized a gain of $500,000 (after accounting for other home improvements and selling expenses). You and your spouse can exclude up to $500,000 since the home is his/her principal residence for at least two years from the date of the sale even if she did not own the house for as long as you file a joint return.
- Example 2 – Same scenario as above. This time you put your spouse name on the title as co-owner on January 15, 2008 but he/she did not move in until March 1, 2008 because he/she still has not quit his/her previous job located in another state. Since the home was sold on February 15, 2010 and he/she did not live in the house for two or more years, you can only exclude up to $250,000 on the gain even if he/she owns the house for more than two years. On the other $250,000.