You have owned your house for several years and have now earned a profit. Take the time to calculate your tax liability – you might be suprised at the savings.
If you have a profit from the sale of your residence, this profit is considered a capital gain and is subject to income tax. However, the tax law allows you to exclude all or part of that gain from your taxable income if you meet certain criteria. For many home owners this means they will not have to pay tax on the profit from the sale of your house.
Here is how you calculate the tax:
1. House exclusion: An individual can exclude $250,000 of gain and a married couple filing a joint return gets a $500,000 exclusion. You can use this exclusion once in every two years, unlike the old law which made it a once in a lifetime exclusion. This exclusion is for your primary home. If you are getting a divorce and selling the primary residence make sure you see your CPA to optimize the use of this exclusion.
Sometimes a couple will divorce and continue to own the house as joint tenants. In that case, each individual will use their $250,000 exclusion on the sale of the house. Read the fine print from the IRS on how this works and make sure you follow the guidelines carefully to be sure you don’t lose this exclusion.
2. To meet the ownership test, you must have owned the home for at least two years in the five years ending on the date of the sale. To meet the use test, you must have lived in the home as your main residence at least two years during the five years ending on the date of the sale. At least one of the spouses from the marriage needs to meet the use test to qualify.
3. There are some special circumstances where you will be exempted from the ownership or use tests that would still allow you to exclude a portion of the gain realized from the sale of your home. These special circumstances require a specific reason for your exemption that include: serious health issues, a change in your place of employment, or certain unforeseen circumstances such as a divorce or legal separation, natural or man-made disasters resulting in a casualty to your home, or an involuntary conversion of your home.
If you know that you qualify to exclude all of the gain from the sale of your home filing this information on your federal income return is not necessary. However, if you are not allowed to exclude all of the gain you will need to file Schedule D, Capital Gains and Losses, and Form 1049 to report the total gain, the portion than can be excluded, and the portion that is subject to a capital gains tax.
For more information and specific details on how to report the capital gain from the sale of your primary home, go to the IRS Publication 523 called “Selling Your Home.” You will also find information on how to calculate the cost basis of your home. You will need the cost basis to determine the capital gain.
You can also go to the IRS website at www.irs.gov or by calling 800-829-3676.
Know your options BEFORE you file for divorce. You and your spouse may agree to do some refinancing before either person files that will facilitate the best strategy for one of you keeping the house, one spouse taking money out of the house for a down payment, or maximizing the cash in your pocket from the sale of the house rather than the IRS. Plan ahead and trust but verify!