There are a lot of myths floating around about the tax rules regarding home sales. We asked our Motley Fool tax experts to share the myths they hear most often and to explain the real tax rules you must follow when selling your home.
There's a lot of confusion about the capital-gains exemption for selling a home, but it's vital to get this right, because it can cut your taxable income by as much as $250,000 in gains for single filers or $500,000 in gains for joint filers. To qualify for the maximum exemption, the property you sell must be your main home. You must have owned the property for at least 24 months within the past five years, and you generally must have lived in the home for at least 24 months during that same five-year time frame. But certain exceptions apply so that people who require treatment at long-term care facilities can generally count their time at those facilities toward the residency requirement. Moreover, those who are disabled only need to meet a 12-month residency test. You can't claim the exemption if you claimed it in one of the two most recent tax years.
Even if you don't qualify for the maximum amount, you may be able to get a partial capital-gains exemption. Those who've claimed the exemption recently or have lived in their homes less than two years can exclude a portion of their capital gains income, based on the amount of time actually elapsed. So if you lived in your home for one year instead of two, you could claim half the maximum exemption -- up to $125,000 for singles and $250,000 for joint filers. The exact calculations can be more complicated, but these general rules will give you a reasonable starting point to evaluate the exemption.
One myth that many people believed until the financial crisis is the idea that you can claim a capital loss on the sale of your home. This is not true. On a related note, you cannot deduct the cost of regular home improvements, though some major improvements and renovations do change the cost basis of your home. Let's go through each one.
For reference, your cost basis is generally the price you paid for your home. If you had your house built on land you own, then it gets more complicated, so we won't delve into that special case, but you can read more about it here.
If you sell your house for more than your cost basis, you owe taxes on your capital gain, as Dan Caplinger mentioned above. If you sell your house for less than your cost basis, then you're taking a loss on your house, but because your house is personal property and not investment property, you're not allowed to claim a capital loss.
Your cost basis can be affected by certain major home improvements and renovations. The cost of any repairs or maintenance that are necessary to keep your home in good condition, but do not add to its value or prolong its life, is not included in adjustments to cost basis. Examples of improvements that increase your cost basis include:
When you raise your cost basis, you lower your tax liability. Note that it's important to keep receipts and good records of all the work done in case the IRS audits you and asks for proof. This is especially important because years may pass between the time you make the improvements and the time you sell your home.
If there's one home-selling myth that just won't die, it's the idea that you can deduct out-of-pocket expenses for moving or preparing your property for sale.
For example, when preparing your home for sale, you're liable to incur some significant out-of-pocket costs -- perhaps repainting your home, repairing a toilet or sink, or servicing a furnace. Although it'd be great if you could write these repairs off as home improvements, they're merely maintenance repairs that aren't deductible on your federal income tax filing.
As always, there are exceptions to this rule. If, by some chance, you're making an energy-efficient modification to your home prior to sale, such as adding a solar water heater, it would be tax-deductible to a certain extent. Similarly, if you're making repairs after being hit by a tornado or hurricane, your repairs may qualify for a tax break under the casualty/loss rules.
Furthermore, moving for personal reasons is never tax-deductible. The only time a tax deduction applies to a move is when it's made for work, and even then there are some restrictions. For example, your new job must be at least 50 miles farther from your old home than your old job, and you must work for 39 of the 52 weeks after you move into your new home.
In short, read up on the tax rules regarding moves and home sales, and don't make any assumptions.