From capital gains taxes to the 3.8% Net Investment Income Tax (NIIT), the tax implications of a home sale can be significant and impact the bottom line. But with the right knowledge and planning, homeowners can make the most of their investment in their home and avoid any potential tax pitfalls.
If you’re selling your principal residence, and meet certain requirements, you can exclude from tax up to $250,000 ($500,000 for joint filers) of gain.
To qualify for the exclusion, you must meet these tests:
- You must have owned the property for at least two years during the five-year period ending on the sale date.
- You must have used the property as a principal residence for at least two years during the five-year period. (Periods of ownership and use don’t need to overlap.)
Additionally, you can’t use the exclusion more than once every two years.
Gain above the exclusion amount
When it comes time to sell a home, there are tax implications to consider if you have more than $250,000 (if single) $500,000 (if married filing jointly) of profit. Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, provided you owned the home for at least two years. If you didn’t, the gain will be considered short term and subject to your ordinary-income rate, which could be more than double your long-term rate.
If you’re selling a second home (such as a vacation home), it isn’t eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 like-kind exchange. In addition, you may be able to deduct a loss.
The 3.8% Net Investment Income Tax (NIIT) is a tax on certain investment income, including capital gains from the sale of a home. If you sell your main home, and you qualify to exclude up to $250,000/$500,000 of gain, the excluded gain isn’t subject to the NIIT.
However, gain that exceeds the exclusion limit is subject to the tax if your adjusted gross income is over a certain amount. Gain from the sale of a vacation home or other second residence, which doesn’t qualify for the exclusion, is also subject to the NIIT.
The NIIT applies only if your modified adjusted gross income (MAGI) exceeds: $250,000 for married taxpayers filing jointly and surviving spouses; $125,000 for married taxpayers filing separately; and $200,000 for unmarried taxpayers and heads of household.
For example, if a single taxpayer sells their primary residence for a capital gain of $400,000 and their income for the year is $200,000, they would not owe any NIIT on their capital gains. However, if the same taxpayer's income for the year is $300,000, they would owe the 3.8% NIIT on $50,000 of their capital gains.
It's important to note that the NIIT only applies to capital gains that exceed the exclusion amount for the sale of a primary residence. In other words, if the homeowner is able to exclude all of their capital gains from the sale of their home, they would not owe any NIIT on those gains.
Two other tax considerations
- Keep track of your basis. To support an accurate tax basis, be sure to maintain complete records, including information about your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed for business use. When selling a home, homeowners can subtract the cost basis from the sale price to determine the capital gains. The higher the cost basis, the lower the capital gains and the lower the potential tax bill.
- You can’t deduct a loss. If you sell your principal residence at a loss, it generally isn’t deductible. But if a portion of your home is rented out or used exclusively for business, the loss attributable to that part may be deductible.
We're here to help
Depending on your home sale profit and your income, some or all of the gain may be tax free. But for higher-income people with pricey homes, there may be a tax bill. When preparing for a move, contact your tax adviser to help you minimize taxes and answer any questions you have about home sales.