HOW MUCH CAPITAL GAINS TAXES WILL I OWE WHEN I SELL MY HOME?

The rules around capital gains changed dramatically for 2013 so I’m glad you are asking this question now.  I will break it down into separate questions:

What is Capital Gains?

When you sell you home at a profit the IRS considers the profit “capital gains” rather than “ordinary income” such as the income you receive in your paycheck.  Capital gains are taxed different than ordinary income.  So, if you purchased the house for $100,000 and you sell it for $500,000 you have earned $400,000 in capital gains.

Are there any exclusion for Capital Gains on a home?

If you have owned the home for two years and you have lived in the home as your principal residence for two out of the last five years (ending on the date of sale) you may exclude $250,000 of the profit from the sale as an individual.  Married couples can exclude up to $500,000 (if both spouses each meet the ownership and occupancy tests).

There are a few exceptions to these rules—for example, if you had to move before owning the home for two years because of a job change or because you experienced what the IRS designates as an "unforeseen circumstance," such as a divorce or natural disaster. In these situations the IRS will allow you to prorate the exclusion.

And interestingly, the two years residency doesn’t have to be consecutive—you just have to have lived in your home for a total of 24 months out of the five years prior to the sale.

What if I inherited the property?

When you inherit property, such as a house or stocks, the property is usually worth more than it was when the original owner purchased it. If you were to sell the property, there could be huge capital gains.  Fortunately, when you inherit property, the property’s tax basis is “stepped up,” which means the basis upon which to calculate the capital gains would be the current value of the property.

For example, suppose you inherit a house that was purchased years ago for $100,000 and it is worth $500,000 on the day you inherit it. You will receive a step up from the original cost basis from $100,000 to $500,000. If you sell the property right away, you will not owe any capital gains taxes. If you hold on to the property and sell it for $1,000,000 in a few years, capital gains taxes will be calculated on the $500,000 of capital gains you earned.

On the other hand, if you were given the same property, as opposed to receiving it upon the owner’s death, the tax basis would be $100,000. If you sold the house, you would have to pay capital gains taxes on the difference between $100,000 and the selling price. The only way  to avoid the taxes is for you to live in the house for at least two years before selling it. In that case, the exclusions I mentioned above apply.

This is why you always talk to your estate planning lawyer before you give your home to your children.

How much capital gains will I owe?

This is where it gets fun.  Let me take you through the multi-step process that you and your trusted tax advisor will go through:

1. Take the purchase price of your property and add the cost of any improvements. If you bought your home for $300,000, for instance, that would be the basis for calculating your gains. If you later spent $30,000 on capital improvements -- a new roof and a kitchen remodel, for instance -- then your basis goes up to $330,000. This applies only to substantial improvements that add to the home's value, not to repairs. Fixing a leak in the roof isn’t a capital improvement, but replacing it with a newer, better roof would be. Also, if you’ve been billed with a special assessment for neighborhood improvements — $500 toward a new sidewalk, for instance — you can count those too. 
2. Take your sale price and adjust for sale expenses. If you sell a property for, say, $400,000, you can subtract the costs of your real estate agent’s commission, legal fees and any closing costs you agreed to pay. 
3. Subtract your basis from the adjusted sale price. If you have a $100,000 adjusted purchase price and the adjusted sale price is $500,000, for instance, you have $400,000 in capital gains. 
4. Check for any state and federal exemptions you’re entitled to. Have you lived in the house for two of the past five years? 
5. Look at how long you’ve held the property. If you’ve owned the house for less than a year than regular income tax rates apply. If you have owned the house for more than a year you will check the capital gains tax rates for “long term capital gains”.Which capital gains tax rate you will pay depends on which ordinary income bracket you fall into. This could be very good news if you have a low income. For 2014 here are the long term capital gains tax rates:

• 0% if you're in the 10% or 15% marginal income tax brackets

• 15% if you're in the 25%, 28%, 33%, or 35% marginal income tax brackets

• 20% if you’re in the 39.6% top bracket

Bad at math?  Put your numbers into these great calculators:


Simple calculator: http://www.moneychimp.com/features/capgain.htm


Calculator with the ability to make adjustments for improvements and consideration of 1031 exchange possibility for rentals:

 http://www.orexco1031.com/Calculators/CapitalGains.aspx