Capital Gains Tax Explained
Under the federal tax code, citizens are expected to pay taxes not only on earned wages, but also on money made through investment and other types of financial activity. Until 1997, even money resulting from the profitable sale of a personal home was subject to capital gains tax, although there were some ways to lessen or eliminate the tax burden. There was also a potential exclusion of $125,000, but it involved detailed record-keeping and represented a lifetime limit that applied only to sellers aged 55 and over.
The Tax Exclusion Law of 1997 changed all that. For the past 20 years, for the majority of home sellers, any money realized from a home sale has been exempt from federal capital gains tax. However, if you have lived in a home for 30 years, or you're in an area that has seen substantial appreciation in property values, it is possible that you might be liable for payment of tax.
Even so, though, the amount of capital gains tax levied on a home sale is really nothing to fear.
How the Tax Exclusion Law Works
The two-decades-old law applies to every sale. It is not a one-time-only exclusion, but there are some requirements:
- The exclusion applies only to a primary residence. Second homes and investment properties do not qualify
- To qualify for the tax exclusion, you must occupy the home as your primary residence for two of the last five years
- Individuals qualify for an exclusion of $250,000
- Married taxpayers filing jointly have a $500,000 exclusion
- The exclusion may be used multiple times; and, finally
- No special reporting or backup documentation is required
There are, however, some things you will want to remember.
The law currently in effect was enacted in 1997 to give homeowners relief from the previous need to "reinvest" proceeds from a home sale into another property. In effect, owners today can move approximately every two years and pocket the profits from each sale. But it's important to remember that the law applies only to a primary residence.
If you own a second home or vacation property that you move into when you sell your home, it will not automatically qualify for the same exemption after you live in it for two years. In 2008, a provision of the Housing Assistance Act enacted tax levies for the portion of profit earned while property was owned for rental or investment purposes.
Why Does It Matter?
For most people, the capital gains tax exclusion makes home ownership an even sweeter deal. In addition to authorized tax deductions for mortgage interest and property taxes, down-the-road profits upon sale of the home can represent a substantial chunk of cash for retirement or for other investment.
Even if you realize more from a home sale than the $250,000 or $500,000 sum (which is certainly possible with greatly appreciated homes in Centennial Hills, for example), the tax due is based on overall taxable income and tax rate. Currently, long-term capital gains taxes range between 0 and 20 percent.
There may be changes coming, but for now that means:
If you have owned property that has appreciated over the years and you decide to sell, you might under a worst case scenario be liable for a 20 percent tax bill on any gain over $500,000 for a married couple.
As most people realize, taxes can be confusing, and state and local laws also impact your tax liability. If you plan to sell a home and anticipate a substantial profit, it is always wise to seek professional advice about tax and reporting requirements.