Know the rules so you don't get a BIG Surprise!
One of the best deals in the tax code is the exclusion of the gain on the sale of your home. This generous exclusion could result in up to $500,000 remaining tax free.  

The tax rules are changing constantly, however, and loopholes are being closed on a regular basis. Knowing the rules could help you to avoid a big surprise when you sell your home.  

Prior to 1998, when you sold your home you had to roll over any gain into another house within the time period allowed. That has all changed and most of the time there is no need to worry about owing taxes when you sell your home, even if you clear a hefty profit.  In many cases there is no requirement to report the sale on your tax return.

The exclusion amount, if you file as single, is $250,000 and $500,000 for married filing jointly.  There is an exception that allows a surviving spouse to continue to use the $500,000 exclusion if the jointly owned residence is sold within two years after the death of the spouse. 

NOTE: You cannot deduct a loss on the sale of your personal home.

Your home can be a house, a houseboat, a mobile home, a co-op apartment, or a condominium. If you have more than one residence, you can only exclude the gain on the sale of your principal residence. Generally, the residence where you spend the most days during the year is your principal residence.

Below are some common situations where you could end up owing tax on all or part of the gain from the sale of your home:

You live in the house for two of the last five years
If you sell your home at a gain before two years are up and you don't qualify for any of the exceptions, you pay tax on the gain. However,there are many exceptions. For example, if you have to move because of health, a job transfer, or other unforeseen circumstances, you still may be able to exclude some of the gain at a prorated amount. 

The house appreciated in value when you were not living in it
Prior to 2008, you could have a vacation or investment home for years -- decades even -- and watch it go up in value. You could move in and live there for two years before selling, and be eligible to exclude up to the maximum amount of gain. This loophole has been closed.  In this case, you cannot exclude the gain based on the increase in value while you were not living in the house. 

The house went up in value more than the exclusion amount
It's not far-fetched, especially in some parts of the country, that the gain will be greater than the exclusion amount.  In that event, you will pay capital-gains tax on the gain over any exclusion amount.

It wasn't your principal residence
The rules for excluding the gain on the sale of your home apply only to your principal residence. If you have a second home or any other home or investment property, you may owe capital-gains tax when you sell.

You or your spouse already took an exclusion within the last two years
You can take this deduction only once every two years. For example, if one spouse sold a home before they got married, you will want to wait two years after the sale before you sell another house at a gain.

The rules can be confusing, but this exclusion is still one of the best deals in the tax code.  Our job is to keep up with and understand the constantly changing financial environment.  If you have any questions, give us a call.

Record-keeping is an essential component.
To determine the gain or loss on the sale of your home, you first must determine the Tax Basis. 

Basis begins with the cost you paid for the home and acquisition costs such as:
  * Inspection, appraisal and evaluation fees
  * Transfer taxes, Notary fees, and legal fees
  * Closing costs
  * Deed and mortgage recording charges
  * Title search and title insurance premiums
  * Survey costs

After that, there are expenses that can increase your basis. These include improvements that materially add to your home's value or prolong its life. But, just making the expenditures is not enough. You must keep receipts, canceled checks, or other proof.  Remember with the IRS, if you can't prove it; it didn't happen.

Improvements, alterations, replacements, and additions that typically increase your basis in your home can include:
  * New roof, insulation, vinyl siding
  * Additions (porch, deck, terrace, patio, garage)
  * Bathroom renovation; kitchen remodeling
  * Sprinkler system; fences and gates
  * Central heating or air-conditioning equipment
  * New gutters, leaders, drain pipes
  * New stairs; walkways or driveway; landscaping
  * In-ground swimming pool
  * Storm windows and doors; screens; window replacements
  * Telephone and cable outlets; security system
  * Electrical wiring, service panels, outlets
  * Septic tank (new or replacement)
  * Conversion of basement or attic to living space
  * Fireplaces
  * Closets, cupboards, or room dividers

Not all home-related expenses will reduce your gain. Expenses that keep your home in good repair usually won't reduce your gain unless they are part of an extensive remodeling or renovation plan.

You could get a step-up in Basis.
When you inherit from someone other than your spouse, you generally receive a step-up in basis.  The basis to you, the beneficiary, is stepped-up from the basis of the original owner to the current market value at the date of death.  You now have several choices on what to do with this inherited home.  Based on the real estate market, your needs, and your financial situation, you may, sell, move in, or turn the house into a rental property.

If you sell the house, you pay taxes only on gains over the stepped-upbasis. Currently, the long-term capital gains tax rate can run upwards of 20%, depending on your tax bracket.

If you decide to move into the house, your basis starts with the stepped-up basis, and you may qualify for the exclusion of gain when you sell.

Turning your inherited home into a rental could provide a big tax benefit, too.  The depreciation expense will serve to reduce your taxable rental income.  For tax purposes, the house (not the land) is considered a depreciable asset, and a certain percentage of its value can be deducted annually. You can also depreciate improvements, such as a new roof, provided they add value or will extend the property's life.  The only catch is that you will have to pay back that depreciation to the Internal Revenue Service when you sell. That means you' will owe more in capital gains, if there are any.  You also won't qualify for the exclusion since the house isn't your principal residence.

If you inherit the house from your spouse, you retain the original basis.  It is important to remember that you may be eligible for up to the $500,000 exclusion of gain if you sell within two years of the date of death of your spouse.