When you sell a house, you hopefully make a profit. How much profit you make, how you used your house and how long you owned it all play a factor in whether or not you will pay income tax on your windfall, and how much. Understanding how a house sale does or doesn't create a taxable capital gain will help you better calculate what your net profit might be.
What Was Its Use?
One of the first factors that influence your potential income tax liability on the sale of the house was its use. If the house was your primary residence for any two of the past five years, you do not have to pay capital gains tax on the first $250,000 of your profit if you are a single filer, and $500,000 if you are married.
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If you flipped a house for profit or used the house as a rental property, you won't qualify for capital gains tax exclusions. You can learn more about qualifying for the exclusion at the IRS website page, "Topic No. 701 Sale of Your Home."
Read More: Form 1040: What You Need to Know
How Long Did You Own It?
Another factor that affects your income tax on the sale of a home is the length of time you owned it. Flippers who buy and sell a house in a matter of weeks or months can't claim it as their primary residence and get the tax benefits. If you lived in a house as your primary residence for two years during the past five years, you will get the capital gains exclusion. The two years don't have to be consecutive years.
This law might change from tax year to tax year (for example, the length-of-ownership requirement might change by a year), so make sure to consult with a tax professional before you make plans to sell your house.
If you owned two homes during the past five years, you can't claim them both as primary residences and get the capital gains tax exclusion if you sold them within two years of each other. You should be able to get the exclusion once, for one of the houses. Married couples filing jointly can't each claim one of the houses as a primary residence.
How Much Was Your Gain?
Another factor that will affect your income tax situation when you sell a house is how much profit you made. As of 2022, the first $250,000 in profit you make is tax-free for a single filer and $500,000 for a married couple.
How do you know how much profit you made? Working with a tax professional or qualified real estate agent, you'll look at the price you paid for the house, then factor in certain improvements you made and your closing costs. Read IRS Publication 523, "Selling Your Home," to learn more about making improvements that can reduce your taxes.
If you end up making more than $250,000/$500,000 (based on your filing status) from the home sale, the amount of capital gains tax will depend on your income.
Other Tax Scenarios
You might be able to do a 1031 Exchange when you sell your house. This is a situation where you sell your house, but use the proceeds to buy another property, which eliminates your capital gains taxes, explains RealtyMogul.com.
If you had capital gains losses during the year, that will come into play when estimating your tax liability, as well. You might also need to pay capital gains taxes if you are subject to expatriate taxes. Work with a qualified tax professional to find out what your income tax liability might be, based on all of the factors related to the sale of your home.