The Taxpayer Relief Act of 1997 allows you to avoid taxes on profits -- up to $250,000 if you're single and up to $500,000 if you're married -- when you sell your primary residence. However, sales of rental, commercial or other income producing property does not enjoy this beneficial tax treatment. While there is no exemption for profits generated from sales of residential properties you don't live in, your income -- above the cost of the property sold -- should be treated as a "capital gain" for tax purposes, which enjoys lower tax rates than for ordinary income.
Primary Residence Tax Exemptions
The 1997 Taxpayer Relief Act defined this major tax exemption for homeowners. Even before this legislation, the over-55 group had a $125,000 profit tax exemption when they sold their primary residences. When most homeowners, regardless of age, sell one primary residence, they face no tax consequences. However, newer homeowners must stay abreast of IRS rules, as the rules can change quickly.
Non-Primary Residence Real Estate Profits
No tax exemptions exist when you sell other property and then invest profits in a new home. However, in most cases, profit from non-primary residence sales, assuming you have owned the property for the minimum time as specified by prevailing tax rules, will be classified as long term capital gains. This tax treatment is usually beneficial for taxpayers because the tax rates on gains are lower than they are on regular income. However, Congress also changes these tax treatment rules for capital gains on a periodic basis. Stay aware of current IRS capital gains tax rules.
If you've sold a home or condo, to enjoy the tax exemption, you must have owned and lived in the residence for at least two of the five years prior to your sale. The two-year requirement does not require you to live in the home for two consecutive years. If you had a job or school attendance that forced you to be away from your primary residence, as long as you occupied it for at least two years, you qualify for the exemption. Even if you rented the home for a period before buying it, as long as you occupied it as your primary residence for at least two years, you qualify for the generous tax exemption.
Expenses and Improvements
Whether you're selling a primary residence or an income-producing property, you can add the selling expenses and the cost of improvements to the cost basis of the real estate before you figure any tax liability. This feature can be very important when you sell an investment property to minimize the tax consequences or when you become concerned about prevailing tax rules regarding total tax exemptions for reinvesting in owner-occupied primary residences. Take advantage of prevailing tax rules to minimize your tax consequences.
Homeowners should keep up with federal and state tax regulations regarding primary residences and other real estate. Making buying, selling or investment plans based on outdated information can be costly. You should understand the basics of the prevailing IRS tax treatment of real estate transactions and be alert for changes. Consult with a trusted tax professional or accountant before making any major real estate buy/sell decisions if you're unsure of the tax consequences.