Are you planning on selling your home, or have you already sold your home this past year and you’re wondering whether you will owe the IRS taxes? If so, you are in the right place.
In this video, I’m going to explain what taxes you’re going to owe for selling your home, and even more importantly, I’m going to share with you how to take full advantage of a little-known tax law that can save up to $500,000 in capital gains taxes and decrease your tax liability.
I will also explain how to handle capital gains on home sales over $500,000, how to navigate the ins and outs of IRS Section 121, and what to do if you don’t qualify for the full Section 121 Exclusion.
If you don’t already know me, my name is Sonia Narvaez, I’m a licensed CPA in the Orlando area and I serve clients globally. Now let’s dive in.
What’s the Section 121 Exclusion and Why it Matters to You?
The Section 121 Exclusion allows homeowners to exclude up to $250,000 in gains if single, or $500,000 if married—from their taxable income when selling their primary residence.
To qualify for the full Section 121 Exclusion, you need to have lived in the home for at least two of the last five years.
Here’s a real-world example of how the section 121 exclusion works
Imagine you purchased a home for $200,000, and you lived in it as your primary residence for 2 years.
Later on, you sell the home for $550,000, which results in some capital gains, or does it?
To calculate our capital gains or our profit, we need to use this simple formula. It’s Capital Gains = Sales Price − Purchase Price – Capital Improvements.
What are capital improvements? I’m glad you asked. Capital improvements are any improvements you made to the property.
Things like bathroom remodeling, floor replacements, roof replacements, and pool additions. They are all deductible when calculating capital gains.
Now, let’s get back to our example
So, we have the sale of the home at $550,000. First we will subtract the cost of the house when we purchased it. That’s $200,000. And then we will subtract the $50,000 we spent putting in that nice pool we bought last Summer. Now, that leaves us with $300,000 in capital gains but wait!
Now comes the good part.
The section 121 exclusion allows us to deduct either up to $250,000 as single filer or $500,000 if you’re married and filing jointly.
So in our example here, if you’re single, you take the $300,000 in capital gains and subtract the $250,000 deduction and that leaves you with just $50,000 in capital gains. It’s important to note that how you will be taxed on this $50,000 is dependent upon which tax bracket you are in.
Now, if you’re married filing jointly, you take the $300,000 in capital gains and subtract the $500,000 deduction and that leaves you with $0 in capital gains. How about that, you now owe $0 in taxes.
Qualifying for Section 121 – The Full Exclusion
Now, it’s very important to note here that not everyone qualifies for the full deduction for the section 121 exclusion. In my experience, I have seen people make critical errors when selling their homes and thus get stuck with some large tax bills because they failed to meet the criteria of the section 121 exclusion.
And I really don’t want you to make the same mistakes and see you cut a big check to Uncle Sam.
To take full advantage of the section 121 exclusion and get the full benefit, you must have owned the home for 2 years,lived in the home as your primary residence for at least 2 of the past 5 years (even if you rented it part of the time that’s OK)
and thirdly, could not have claimed the exclusion on another home in the past 2 years. So no double dipping!
Now, many people won’t qualify for the full exclusion and that brings up my next point which is it’s possible to get a partial exclusion if you don’t meet the 3 criteria I just listed.
Qualifying for Section 121 – The Partial Exclusion
So, what happens if you don’t meet the two-year rule? That’s where the partial exclusion comes in! This rule lets you claim a prorated portion of the exclusion if your move is due to specific, unexpected life events. These include:
- Job relocations that require a move 50 miles or more away.
- Health issues that force you to relocate
For example: If your old job was 10 miles from your home and your new job is 60 miles away, you would meet the 50-mile requirement.
For example: A physician recommends a move to treat or prevent a disease, illness, or injury for you, a family member, or a close dependent.
This can also include relocating to a drier climate for respiratory issues or closer proximity to a medical specialist.
Other unexpected life events include:
- Natural Disasters such as Hurricanes, earthquakes, floods, or other federally declared disasters.
- Death: This could be the death of a co-owner, spouse, or close family member.
- Divorce or Separation: So a legal divorce, separation, or the end of a domestic partnership.
- Multiple Births from the Same Pregnancy: Having twins, triplets, or more children unexpectedly.
- Other Hardships: this can include a Job loss or loss of income that makes it impossible to afford the home.
- And lastly, if your house receives significant property damage, you can qualify for the section 121 exclusion.
But how does the section 121 partial exclusion work? I mean if you are not getting the full credit, how much is the IRS willing to give you?
Well, if you’re single and let’s say you lived in the house for half the required time — only one out of two required years.
Instead of receiving the full exclusion of $250,000, you would qualify for 50% of that which is $125,000.
So, you can exclude up to $125,000 of your capital gains from taxes.
Of course, the IRS will need proof. Documentation is key. Things like job transfer letters, medical records, or any paperwork that supports your case should be documented and saved.
If your situation qualifies under the mentioned exemptions, also known as the Safe Harbor Rules, you may not even need special approval.
Free Complimentary Consultation
As i mentioned earlier, my name is Sonia Narvaez. I’m a licensed CPA and wealth-building
strategist with over 25 years of experience.
If you have any questions about how to take advantage of the latest tax savings strategies, don’t hesitate to contact us.
To get your FREE complimentary consultation with a member of my team, simply click this scheduling link, and pick the time that works best for you. We would love to help and meet with you.