The House and Senate income tax reform bills offer a lot of changes to many tax payers. Many are debating the pros versus cons of tax reform. The main goal of the reform appears to be to help the American tax payers and further stimulate the economy. One potential area of concern in both tax reform proposals deals with the capital gains tax on the sale of real estate. First of all, we are not representing this as tax advice or that we are tax professionals. Rather, we want to share types of questions or topics that sellers, Realtors, CPA’s, mortgage professionals, and more should discuss. Plus, this discussion should take place before listing the home for sale.
2017 Capital Gains Tax Exclusion on Sale of Home
Per the IRS topic number 701 – Sale of your home, “If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income. You may qualify to exclude up to $500,000 of that gain if you file a joint return with your spouse.”. Sounds pretty good, doesn’t it? So, how do you get this capital gains tax exclusion? To qualify in 2017, the seller of the home must have owned and used the home as the primary home for 2 of the last 5 years of ownership.
This may only be done once every 2 years and there are other potential exceptions such as for military, government housing, or installment sales. It is always important to ask your tax professional to see if you qualify for this exclusion. This has been a very popular way for homeowners or flippers to buy, occupy 2 years, sell for a profit, and not pay income taxes on the profit. The profits are not even required to be put down on another property to avoid this tax! But if the proposed tax bills hold and it is expected to, this exclusion is changing for the worse in 2018.
Closing a few days into 2018? Have a quick discussion to determine if closing in 2017 would benefit the seller’s future tax bill. This is a very important discussion for the seller, listing agent, and CPA if the home was occupied between 2 and 5 years. Maybe offer the buyer an incentive to close in 2017?
Will I Pay Income Taxes If I Sell My Home in 2018?
So, these were the old rules. But, both new tax bills that need to be negotiated into one, will increase the number of years required to exclude capital gains tax bills. Instead of the 2 out of 5 year rule, it would be 5 out of 8 years! So a homeowner looking to sell needs to see where he/she stands in this 8 year period. Occupying the home less than 5 out of the last 8 years would mean a potential tax bill. Conversely, occupying the home at least 5 of the last 8 years could result in no capital gains tax consequences up to the limits allowed.
Should I Sell My House and Pay the Tax?
First of all, if you are paying a capital gains tax, congratulations! You made a profit on your home after all expenses and hopefully enjoyed the home along the way! Key points are “profit” and “all expenses”. You made a profit and you need to remember to calculate the allowed expenses to lower your tax burden. Items such as Realtor commissions, seller closing costs, seller paid costs for the buyer, and certain improvements made to the home could reduce the taxable profit. This is one of those areas where having a relationship with a CPA comes in handy. In addition to the CPA, keep receipts for everything to do with the home. It could be a write-off when you do sell the home.
Buying a Home After Selling
If you are considering a sale before 5 years, then there must be reasons and there are plenty! Here are a few examples to sell the current home even if the profit will be taxed. Life happens which means change. Although, about everyone wants to pay less taxes, there are good reasons to sell. And again, you are making a profit!
- The perfect house came available
- Family size has increased
- Divorce or separation
- Changing school districts
- Job relocation
- Tired of current house
- Shorter commute to work
- You have a chance to make a profit
There are many other reasons to sell, pay a potential tax, and purchase another home. Basically, the homeowner needs to weigh the pros versus the tax as well as have a thorough discussion with an experienced Realtor.
Capital Gains Affect on Military Sellers
Military families are on the move quite often which means buying and selling often. Service members receive their permanent change of duty station orders (PCS) and usually that means moving the family. Living in a home 2 out of the last 5 years isn’t so tough. But, living in a home for 5 years pushes the threshold a lot higher for not having to pay a tax on the gain from sale. A huge benefit for military sellers is that they can typically purchase the next home with no money down. This is accomplished through a VA home loan. Since a down payment may not be required and it is customary (not required) for the seller to pay the service member’s closing expenses, having the whole profit isn’t as important. Therefore, any profit made on the home could be used for investing, paying debts, or down payment on a new home.
What if Military Buyers Sell in Less Than 5 Years and There is No Profit?
If there is no profit, then there is no capital gains tax to pay! Keep in mind that just because the sales price is higher than the original purchase price, that doesn’t mean there is a taxable profit. There are ways to lower that profit or even get rid of the whole thing. This is another one of those moments where it helps to have a great CPA who can provide solid tax advice.
Prepare for Listing Your House for Sale
If a seller is going to depend on a Realtor or tax professional to provide solid advice on selling, it is important to keep documentation organized and safe. Examples of items to keep for an eventual sale include…
- Settlement statement or closing disclosure from purchase
- Closing disclosure from recent refinance
- Receipts for all home improvements
- Warranties for appliances and other fixtures
- Paint, tile, hardwood samples & names to match later
- Lease contract(s) on the home over last 8 years
Great Opportunities in Real Estate
Hopefully, this article has provided a better understanding of the potential income tax law changes. Plus, it should help homeowners better prepare for a potential sale. Although, this could be looked at as a potential negative in selling a home, there are many reasons why the housing market will continue to be strong. Plus more and more families are looking to buy and be a homeowner. Check out one of our recent articles “Will new tax proposals be the death of real estate?” and you will see there are a lot of positives for the taxpayer. Many areas will lower tax burdens which make it easier to buy!
There is certainly opportunity for a lot of upside in real estate. Just involve professionals in your decision. The worst part of all of this as a seller would be to be uninformed and find out next tax season that a large, unexpected tax bill is due. Even worse would be if all proceeds from the previous sale were spent. No one has a crystal ball you can speak to experts to gather information and make an informed decision. If you are a seller looking to buy and are concerned about your scenario, contact us to discuss.
Realtors can get in front of this and if approached the right way, will outshine other Realtors. We have several ways to implement a listing agent strategy that we are happy to share. Please give us a call to discuss.
This article is not tax advice. Always seek tax advice from a licensed tax professional or certified public accountant.