As a lawyer who is passionate about educating the public, I find that a lot of people are unaware of certain laws that affect them. At the same time, certain laws seem to stick in people’s minds, even decades after the law has changed. How many of you have heard that you have to reinvest the proceeds of the sale of your home into a new primary residence of equal or higher value in order to avoid paying capital gains taxes? I know I had heard that law and yet this law was eliminated in 1997, which was the year that I started practicing law and purchased my first home. So it was something my parents must have talked about and even though it’s been 22 years, we have clients who are reluctant to sell their primary residence because they do not want to get hit with capital gains taxes. Here’s what the law is today. Knowing it may relieve some of you and allow you to make a move that you’ve been wanting to do for years.
Under the 1997 Taxpayer Relief Act, each person is given an exemption of a $250,000 gain on the sale of the primary residence. This means if a person purchased a home for $100,000 and then sold it 10 years later for $200,000, the full $100,000 gain is excluded from taxation. A married couple filing jointly has a $500,000 exclusion, even if only one of the couple owned the property.
As with every tax exemption, there are certain requirements that must be met to qualify. First, the exclusion only applies to the primary residence and only if the individual/couple resided there for at least two years. Second, if the taxpayer took deductions on the home for a home office or otherwise, the full amount of the deductions taken over the course of the ownership reduces the exemption.
At the closing, if you can affirm that you meet the requirements of the exclusion and the full sales price of your home is less than $250,000 (for an individual ) or $500,000 (for a married couple), then the sale does not get reported to the IRS. If the sales price exceeds the exemption, then the sale is reported to the IRS by the closing attorney; however, this does not necessarily mean that you will owe taxes. For example, if an individual sells a primary residence for $350,000 and otherwise meets all of the requirements of the exemption, the transaction will be reported to the IRS on a 1099-S. The individual then needs to report the sale on his or her tax return for that year, along with the individual’s cost basis in the property (price paid plus capital improvements). For example, if he paid $250,000 for the property, his gain is $100,000, which falls under the exemption and no taxes are owed. If you ignore the 1099-S and do not report anything, then IRS will presume that the sale price is all gain and will bill you accordingly. This is not a pretty bill to receive!
If you are concerned about your potential exposure to capital gains taxes on the sale of real estate, please contact us or your accountant. Don’t be afraid to downsize!