As the pandemic has continued the housing market in many parts of the country has heated up. Many now see working from home as a long-term situation and they have made the move to locations they have always wanted to live in or giving up the crowded cities for an area with more wide-open spaces. For many, this has been the opportune time to sell their current home or vacation home for what they believe to be maximum profit. But, with the sale of a home and cashing out the equity on your property it is natural to question if this is taxable income.
The IRS lays out rules to guide you in this situation and to help determine if you must pay tax as well as how much tax you are required to pay. If you were to sell your current home in which you have lived in as a permanent residence the IRS provides an excludable amount of up to $250,000 ($500,000 for a married couple). For instance, if you purchased your home 6 years ago for $250,000 and sold it for $700,000 your profit would be $450,000 and you would owe capital gains tax on $200,000 (a married couple would be under the $500,000 limit and would pay no capital gains tax in this situation). To qualify for this exclusion, you need to fulfil the following:
- It must be your principal residence.
- You must have owned the property for 2 of the last 5 years before you sold it.
- You must have lived in the home for 2 of the last 5 years before you sold it. (some exclusions apply for members of our military and for the disabled).
- You must not have already claimed this exclusion in the last 2 years before the sale.
- It must not have been acquired through a 1031 exchange in the last 5 years.
- You must not be subject to expatriate tax.
If you do not qualify for this exclusion using the metrics above, then the entire profit you made from the home sale may be subject to capital gains tax. There are two types of capital gains taxes; short-term capital gains tax will generally be a taxable amount equal to the standard income tax rate you pay on other earned income, and long term capital gains tax which has rates from 0% up to 20% depending on your unique tax situation. Generally, the long-term capital gains tax is the much more desirable tax rate and to qualify for that rate you must have owned the property for at least one year before the sale.