Uncle Sam cares about you a lot. So much so, that when you sell your home, he wants to know all about it. Knowing how much of your selling price is subject to income taxes helps you know what records to keep. In addition, you can better budget for how much you'll be able to put toward your new home.
Taxes on Gains
Your house is a capital asset for tax purposes, which means that if you've owned it for at least a year, any taxable gain qualifies for the lower long-term capital gain rates rather than the higher ordinary income tax rates. For example, in 2012, the maximum rate on long-term capital gains was15 percent compared to a maximum ordinary income tax rate of 35 percent. If you've owned the house for less than a year, you're stuck with a short-term capital gain, which is taxed as ordinary income.
Income From Sales
If you've sold a house before, you know that the sales price doesn't match the amount that gets deposited into your bank account. You've got to pay your real estate agent, any advertising fees, legal fees and sometimes even loan costs for the buyer. All of these decrease the amount the IRS credits you with receiving for tax purposes. For example, if the selling price of your house is $200,000 but you paid $8,000 in expenses, your sales income would be only $192,000. Your gain isn't reduced if you use the proceeds to pay off your mortgage or if you use it to buy a new home.
Adjust for Basis
Only the amount of sales income that exceeds the money you paid for your house, called your adjusted basis, is taxable income. Your adjusted basis includes not only what you paid for your house, but also any amounts you borrowed to buy the home. For example, if you bought a house with a $20,000 down payment and a $160,000 mortgage, your basis is $180,000. It also includes any improvements you've made that are still part of the house. For example, if you upgraded the windows four years ago, and then upgraded them again last year, only the most recent window upgrade cost would increase your basis. Repairs, such as window cleaning, don't increase your basis.
Main Home Exclusion
If you have taxable gain after accounting for selling expenses and your basis, you may be qualified to exclude up to $250,000 of your gain from your taxes. If you're married, you and your spouse could exclude a total of $500,000. To qualify, you must have owned the house for at least two years out of the last five and used it as your main home for at least two of the past five years. In addition, you can't have used the exclusion on a different house within the past two years.
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