Posted by Unifirst Financials & Tax Advisors

Cashing Out Your Home Tax-Free

Cashing Out Your Home Tax-Free

The rules for selling a home may have been understood by the majority of people better than the few parts of the tax code. At least, that’s what it seems to be. Compared to most of the tax code, the rules are fairly simple but a lot of misinformation is still floating around. 

Many people looking to sell homes missed the fact that the rules were overhauled in 1997 - this is the first problem. The second problem is that the rules would have been overhauled again by the Tax Cuts and Jobs Act (TCJA) in 2017 and received a lot of publicity. The final version of the TCJA, however, did not make any changes to the home sale rules.

The tax rules for home sales was greatly simplified by the 1997 law. The amount of gain you don’t include from income has no relation to the amount you roll over into another home you bought, unlike under the previous law. Using the proceeds to buy another home in order to exclude the gain is not a requirement.

The amount of gain you exclude does not depend on your age as well. If you’re aged 55 and over, you can exclude gains other taxpayers couldn’t under the old law.

The rules today states that a taxpayer can exclude the first $250,000 of gain from gross income if he sells a primary residence. The first $500,000 of gain for married couples filing jointly can be excluded. Any gain that is more than the exclusion amount is taxable as a capital gain. 

The number of home sales or the amount of gain that can be excluded from income during your lifetime has no limit.

To prevent speculators from earning tax-free gains from home flipping, a couple of rules has been designed.

For at least two of the five years immediately preceding the sale, you must have both owned and used the home as a primary residence. The period of ownership and residence doesn’t necessarily have to be concurrent and don’t have to be the two years immediately preceding the sale. This means if you move out of a home but don’t seal it for a few years, you have been given some flexibility.

The full exclusion can also be utilized only every two years. The amount of gain you cannot include in the latest sale is pro-rated depending on how much time has passed since the exclusion was last used. That’s only when a home is sold for a gain before two years have passed since the last home sale at a gain.

The $500,000 exclusion amount for married couples is available even if only one spouse was the owner of the home. But the home must be the primary residence of both spouses for at least two of the five years or only when an amount of $250,000 is the exemption.

Your primary residence is the only thing qualified for the exclusion. The sales of second homes, vacation homes, or rental properties cannot be excluded. Capital gains taxes will be required from your sales of secondary residences.

If you decide to sell both of the homes you owed and maximize the excluded gain, you can first sell your primary residence and exclude the gain from income. Then, for at least two years, move into the second home and make it as your primary residence. You can then sell the second home at that point and exclude that gain up to the limit.

Remember that rolling over the proceeds to another home has no requirement. Regardless of what you do with the money, the gain from a sale is tax-free. A home seller can therefore downsize or move to an area with lower housing prices. You can invest part of the sale proceeds and still exclude the gain.

The surviving spouse has two years to sell the home and take the $500,000 exclusion when a spouse passed. However, it’s required that they met the two-year ownership and residency requirements at the time of the first spouse’s passing. If within two years of the first spouse’s passing the house isn’t sold yet, the amount that can be excluded is reduced to $250,000.

Remember that the computation of the gain from the sale of a home is done by deducting your tax basis in the home from the amount realized from the sale. The cost of improvements to the home as well as the original cost is included in the basis. So it’s best that you add the cost of any improvements you made to the bases before the amount of your gain is computed.

Unifirst Financials & Tax Advisors
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