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Understanding Capital Gains Exclusion on Home Sales
Capital Gains ‘Exclusion’ for Your Home
Homeowners may encounter an unexpected tax benefit related to the sale of their properties, particularly through a provision known as the Section 121 exclusion. This tax break allows sellers to shield a portion of their profits from capital gains taxes. Specifically, single filers can exclude up to $250,000 in profits, while married couples filing jointly can exclude as much as $500,000.
To take advantage of this exclusion, sellers must adhere to the IRS’s ownership and use tests. This means that the homeowner must have owned the property and used it as their primary residence for at least 24 months out of the five years preceding the sale. Notably, these 24 months do not need to be continuous, providing some flexibility for homeowners.
Additionally, eligibility is contingent on not having claimed the exclusion for another home within the two years leading up to the sale.
Any proceeds from the sale exceeding these exclusion limits may be liable for capital gains taxes, which can vary based on the seller’s income. The applicable rates are typically 0%, 15%, or 20%. Furthermore, a net investment income tax of 3.8% could apply depending on the seller’s total investment income.
Homeowners can potentially lower their taxable profits by increasing their “basis,” which is essentially the original purchase price of the home. This can be done by accounting for capital improvements and other qualifying expenses.
Landlords May Only Get ‘A Portion of the Exclusion’
For those who have rented out their homes, the situation changes slightly. According to Mark Baran, managing director at CBIZ’s national tax office, “if you’re renting the home, you’re only going to get a portion of the exclusion.” For instance, if a homeowner sells a home for a profit of $250,000 but rented it out for three of the past five years, they would only qualify for a two-fifths exclusion, amounting to $100,000.
This results in $150,000 of profit that might be subject to capital gains tax, provided adjustments to the home’s basis are not considered.
Conversely, if the homeowner meets the necessary ownership and use requirements and did not rent out the property, they might still be eligible for the full $250,000 exclusion. This distinction highlights the importance of understanding how rental use impacts potential tax benefits during the sale of a residence.
Source
www.cnbc.com