Capital Gains Considerations

Selling Your Home Less Than Two Years After Purchasing It

Here is what I hope to be a succinct answer to a question I am often asked by prospective clients; How much will I have to pay in taxes if I sell my home less than two years after I bought it? The following is what I learned from an article written by Larry McClanehan CASL, CFP, ChFC, CLU from Clackamas, Oregon.

There are essentially 5 parts to consider. Let’s examine each.

 1. How much is the capital gain when you sell?

The Capital Gainis calculated by subtracting your Cost and Eligible Improvements from the Sales Price of your home and adding any Accumulated Depreciation.

Costs include not only what you paid for your home but also what you paid for escrow fees, commissions, inspections, and so forth.Eligible Improvements include any remodeling or other significant upgrades.A capital improvement increases your home’s value, while a non-eligible repair just returns something to its original condition. According to the IRS, capital improvements have to last for more than one year and add value to your home, prolong its life, or adapt it to new uses. Things such as replacing your water heater, adding air conditioning, replacing your windows with, for example, double pane windows are all qualified Eligible Improvements. However, the improvement must be evident when you sell your home. If you replaced a linoleum floor with tile and later replaced the tile with carpet only the cost of carpeting would be qualified as an Eligible Improvement. Finally you must add to the capital gain any Accumulated Depreciation you claimed for the use of a home office, for example.

To summarize Capital Gain = Sale price of your home - Cost of buying your home – Eligible Improvements + Accumulated Depreciation.

2. How long have you owned your home?

If you have owned your home less than 12 months then you have a short-term capital gain. The Capital Gain is then treated and taxed the same as ordinary income.

If you have owned your home for more than 12 months then you have a long-term capital gain. I will discuss the tax rates below.

3. What are the Federal principal residence capital gains exclusions?

If you have owned your home for more than 12 months but less than 2 years then you are not eligible for the exclusions. However, you may be eligible to pro rate the gain if you are buying the new home because of a job change, for health reasons or for unforeseen circumstances. The first two reasons are fairly obvious. Unforeseen circumstances are things that occurred after you bought the home you are selling but could not anticipate at the time of purchase. Divorce, enlargement of your family or getting married if you were single when you purchased your home all qualify as unforeseen circumstances. However, be sure to check with your accountant or financial advisor to be sure as I am not an expert in this area.

Here are some examples.

If you have owned the home you are selling for longer than 2 years and you are single then you are eligible for a $250,000 exclusion. (No tax on the first $250,000 of Capital Gain).

If you have owned the home you are selling for longer than 2 years and you are married then you are eligible for a $500,000 exclusion. (No tax on the first $500,000 of Capital Gain).

If you are eligible to pro rate your gain then you would multiply the $250,000 or $500,000 exclusion by the number of months you owned your home divided by 24 months.

There is one major catch to be aware of. You can only use the exclusion once every two years. In the case of a new marriage neither may have used the exclusion in the past 2 years. This aspect is quite technical and should be discussed with your financial advisor or tax accountant.

4. Federal Capital Gain Tax Rates (2015)

Income Tax Bracket

Capital Gain Tax

10%, 15%

0%

25%, 28%, 33%, 35%

15%

39.6%

20%

5. California Capital Gain Taxes (2015)

California treats Capital Gains on the sale of your home the same as ordinary income so you will pay anywhere from 1.00% to 13.30% depending on your taxable income including the Capital Gain.

I hope this article has answered the question to your satisfaction. Please remember that I am not an expert in this area nor am I qualified to provide tax advice so please consult with your tax advisor before making your decision to sell your home, especially if you have owned it for less than two years. The above information is deemed reliable but not guaranteed.