How to Avoid Paying Taxes When Selling a House
How does selling a house affect your taxes? If you’ve made a profit, you may owe a ton of taxes! Luckily, the IRS has some tax breaks baked into its policy on home sales so that you get to keep more of the profit and hopefully invest it in other property. The deductions fall into two categories.
Your Current Mortgage
When you purchase a house with a mortgage, you have to pay the lender a fee for the pleasure of doing business with them. The IRS allows you to deduct 100% of that fee from your earned income in the year you purchase the home. When you refinance, you still have to pay the lender a fee but the IRS makes you break up the deduction over the course of the loan. If, as part of your sale, you’re paying off the rest of the mortgage, you get to write off the rest of the lender fee in that year’s taxes.
Capital gains are the profit you make when you sell an investment like your home. The IRS has all kinds of benefits for long-term property owners to make the buying and selling of real estate more attractive. Here’s a list:
Exclusion: If you’ve lived in and owned your home for two of the last five years you can exclude up to $250,000 of profit as a single person, or $500,000 as a married couple filing jointly. Most people when selling their home, fall into this category. Especially because they can use an inflated starting price by using the “adjusted basis” below.
Reduced exclusion: If you’ve lived in your home for less than two years but have to move for work, health reasons, divorce or because you had multiple births in one pregnancy (e.g. you need a bigger place because you had triplets), the IRS will give you an exclusion based on the amount of time you lived in the home. For example, if you are a married couple filing together, and you’ve lived in your home for one year, the IRS allows you to write off $250,000 of profit on your home.
You can only claim an exclusion (reduced or full) once in a two-year period. So if you plan to sell another home within the next two years for which you will qualify for a full exclusion, it might make sense not to claim it on this year’s taxes.
Adjusted basis: This is the category where individual tax write-offs happen. To get to your adjusted basis, you start with your original purchase price and then add the following:
- All costs associated with buying the property. These include legal and settlement fees and other closing costs.
- The cost of any improvements made to the property. So if you completed a bunch of upgrades in order to make the property more attractive to buyers, you’re in luck! You can write all of those off. What you can’t write off is anything that’s a minor repair like fixing a leaky roof.
- Any special tax assessments you paid.
- Anything you spent while repairing your home after a natural disaster, less any insurance settlements.
- Any reasonable costs incurred in the process of selling your home including but not limited to: real estate agent commissions, painting, advertising, legal fees, and title insurance fees.
If your spouse dies, their half of ownership in the house passes to you at the current market rate. That means if you purchased the home at $100,000, and when your spouse dies it’s worth $200,000, the IRS considers your original purchase price as $150,000 ($50,000 for your half + $100,000 for your spouse’s half).
Other Tax Write-Offs
If after all of the above, you’re still required to pay capital gains taxes, you can deduct the property taxes you had to pay for the portion of the year when you lived at the property. You might also be able to deduct your moving expenses if you’re selling your home because you’re moving for work.
Nobody likes paying taxes but luckily the U.S. tax code has some real estate-friendly laws that give buyers and sellers a break. If you have questions about your specific tax liability, contact an accountant who can help you. The only thing worse than paying the taxes you owe is not paying the correct amount and getting slapped with a penalty later.