Categorized | Economy, Taxes

Do I Have to Pay Capital Gains Tax on my House?

As the economy is rebounding, and especially the housing market, I feel like this may be an issue on more and more people’s minds.

I had a reader email me this question a few days ago. The gist of their question was just as the title states: Do they have to pay taxes, and more specifically, capital gains tax on the sale of their house? They’ve had the house for a while so the value had increased, they were not underwater.

The answer is: It depends. Exactly the non-definitive type of answer they wanted to hear, I’m sure. Below you will find all of the different circumstances that may change your answer from yes to no, or vice versa.


$250,000 Exclusion

You can exclude $250,000 in profit from the sale of your main home. If you are married, you are allowed to exclude a total of $500,000.

What do I mean by main home?  You need to have owned and lived in the home for a minimum of two years. These two years do not necessarily need to be consecutive as long as they are within the past five years.

You can use this “2 out of 5 year rule” to exclude your profits from the sale of your home each time you sell. For the most part, you can only use this exclusion once every two years.

Well, I said for the most part. So naturally, there are exceptions:

Exceptions to 2 of 5 Years Rule

As I said above, you normally need to live in your house for two years of the past five to exclude $250,000/$500,000 of the profit from your taxes. However, there are a few instances where you can still exclude a portion of the profit.

Location Change Due to Job

Whether you move because you’re relocating with your current company or because you are switching companies, you can exclude part of your gain.

Health Concerns

If you are selling your house for a medical or health reason, you will have to document it. This isn’t like a letter from mom and dad that you used to get for school. You will need a letter from your physician filed away with your personal records in case of an audit. You may want to get more supporting documentation on top of the letter like scans, results, and treatment.

Unforeseen Circumstances

If your house must be sold for something unforeseen, then the above suggestion to maintain documentation stays true. The IRS says an unforeseen circumstance is “the occurrence of an event that you could not reasonably have anticipated before buying and occupying your main home.”

What are a few examples? Natural disasters, war, terrorism, employment, death, divorce, separation, or multiple births from the same pregnancy.

How is the Partial Exclusion Calculated?

So, if you meet one of the three exceptions noted above, you are eligible for a partial exclusion. How is this calculated?

You are essentially pro-rating your exclusion based on the amount of time you lived in your house. You take the amount of months you lived in the house, divide it by 24 months (two years), and multiply that by $250,000, or $500,000 if you are married.

For example, if you and your wife live in a house for 12 months but then must sell it because she had triplets, you would be entitled to exclude: (12/24)*$500,000=$250,000. Anything over a $250,000 must be counted as taxable income.

Short-Term vs. Long-Term Capital Gain

This one is quite simple. If you owned your home for one year or less, the gain should be reported as a short-term capital gain. If you owned the house for more than one year, the gain should be reported as a long-term capital gain.

What is Your Cost Basis?

Cost basis is an important factor to figure out when trying to estimate what your capital gains tax will be.

Your cost basis will be influenced by the purchase price + purchase costs (escrow, realtor) + improvements + selling costs (escrow, realtor) – accumulated depreciation (home office) = Cost basis.

Once you know your cost basis, obviously your selling price – the cost basis will give you either the gain or the loss.

Therefore, your taxable gain will be your gain – your exclusion.

Additional Resources from the IRS

All of these resources will give you more information than you even thought was available!

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MLR is passionate about saving for his future while maintaining a high quality of life. He currently resides in a great town, has a wonderful girlfriend, adopted the cutest puppy ever, and works for a Fortune 500 company.

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19 Comments For This Post

  1. mattress Says:

    Thanks for answering this question in such detail. It was very informative to me and hopefully it will help others as well.


  2. Kyle Says:

    Are those the only exclusions to paying capital gains on the sale of a home? For some reason I thought you could exclude the profit if you used it to purchase a home. I don’t know where I heard that or why I think it but for some reason I was thinking it…
    .-= Kyle´s last blog ..You are Nothing Without a Good Defense =-.


  3. FFB Says:

    This is great to hear. We are in the process of closing on the sale of our co-op and I was wondering if we’d get hit hard by taxes. Looks like we should be ok. Thanks!


  4. MyLifeROI Says:

    @mattress –
    No problem, any more questions… let me know!

    @Kyle –
    Nope, that law expired in 1997 and was replaced with the one I went over above. So that is probably why you’ve heard it! :)

    @FFB –
    That’s always good news, upgrading or downgrading?!


  5. Trent Yeo Says:

    This is an important tax law to understand because it affects so many people. I believe Kyle may be referring to a “1031 Tax Deferred Exchange” where you can place your capital gains from the sale of a property with a 3rd party administrator and then turn around and use those capital gains in your next “like-kind” property without the tax penalty. If you take control of the capital gain, even for a day, you will owe the taxes on it…


    MyLifeROI Reply:

    @Trent Yeo,

    I actually think he was talking about the pre-1997 rules. Before the Federal Taxpayer Relief Act of 1997 was passed, homeowners were offered two options to exclude capital gains taxes: Rollover or once-in-a-lifetime. After, the current system was adopted which works on a per-sale basis.

    What you’ve highlighted is interesting and I didn’t know that, but I do think he was referencing what was once common!

    Thanks for the info on the 1031, though!


  6. Financial Samurai Says:

    MLR, do you own a home yourself? If so, where do you think the housing market is going over the next 3 years?

    I’m looking at some property in Nevada myself, so I no longer have to pay 10% state income tax.
    .-= Financial Samurai´s last blog ..We’re Ignorant Idiots! Please Tell Us Why A Flat Tax Is Not Fair. =-.


  7. Steve@Gutter companies Says:

    I`ve been searching for this for a long time. Thanks for sharing. Steve
    .-= Steve@Gutter companies´s last blog ..Gutter companies =-.


  8. Milford Stpeters Says:

    I have came to your page from Google and found it informative. Thank you for this entry for first time home buyers. It has really inspired me. I will add this to page to my favorites. Thank you again!


  9. DebT Says:

    Hey, that’s some excellent information about capital gains on homes. Hopefully I’ll be in a situation someday where I’ll need to worry about making more than $250k on the sale of my home.
    DebT´s last [type] ..Credit Card Debt Solutions


  10. Kapiti Real Estate Blogger Says:

    Capital gains tax varies from country to country. Some countries like New Zealand don’t currently have capital gains tax on the family home. Countries like Australia have a capital gains tax on property but conditions apply.
    Kapiti Real Estate Blogger´s last [type] ..SHORT WALK TO PARAPARAUMU BEACH- SHOPS ……


  11. Ben Says:

    Yes, some countries don’t have any Capital gain taxes. I worked as a realtor in Netherlands for a while and there was no capital gain tax but in Canada yes there is you need to pay it.
    Ben´s last [type] ..Acquiring Pre Power of Sale Houses


  12. Rob Says:

    I owned my primary residents for 4 years that I lived in then sold it for a profit, So if I get it right I passed the user test and ownership test and do not have to pay Captial gains?

    Btw wonderful site.



  13. Farret Says:

    paying taxes is something legal that any citizen is obliged to do. if the law says so, then just follow it. Eventually, if many find this inappropriate or to much, somebody will voice out or amendments will be done.
    expert on Full Term Pregnancy


  14. Purehoney Says:

    You answered my question…My husband & I built the house, lived there since 1989 now I am a widow, can I take the 250,000 and then some? Have gone into a partnership and bought a condo.

    Thanks for your help


  15. house cleaning grand haven maidservice cleaning company Says:

    great put up, very informative. I’m wondering why the other specialists of this sector do not notice this. You should proceed your writing. I am sure, you have a great readers’ base already!


  16. salem Says:

    what if it is not your primary residence and you sell it and profit? How are you taxed then?


  17. sotavento barcelona Says:

    Excellent post. I was checking continuously this weblog and I am inspired! Very useful info particularly the final section :) I handle such info a lot. I was looking for this particular information for a very lengthy time. Thank you and good luck.
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