Those who choose to sell a primary residence - whether they've lived in the home for a year or a lifetime - must be mindful of reporting requirements for Federal and State Tax purposes. Good record-keeping is a must - especially on residences with significant appreciation.
Let's look at the basic rules applicable to Federal Taxes. First, there's the "2 out of 5 years" rule. This one is fairly simple, if you've lived in the residence you're selling for at least 2 out of the past 5 years up to the date of sale, then you likely qualify for the full exemption. But you've also had to OWN the property for 2 out of the past 5 years. What's crazy? It doesn't necessarily have to be the SAME 2 years that you lived and/or owned the property. That one is too confusing for this post...just know if it applies to you, it's worth looking in to.
Furthermore, there are potential exceptions and or qualifiers to this rule that might get you at least a partial exemption if the 2-out-of-5 rule doesn't cover you. Email us for questions on this.
How much is the exemption? As it has been for several years now, there's a $250,000 exemption for singles, and $500,000 exemption for married couples. What does this mean? It means if you're a single person selling your house for a $200,000 capital gain and you meet the test above, then that $200,000 capital gain will not be subject to income tax (although the sale MUST still be reported on your tax return in the year of the sale). In cases where a spouse has passed away and the surviving spouse does not remarry, the surviving spouse still has "access" to the $500,000 exemption provided the other tests are met.
So how do you calculate the gain? What are the net proceeds from the sale after closing costs vs the purchase price (plus closing costs) from the original purchase? Don't know? Now's where we talk about record keeping. When it comes to your primary residence, ignore everything you hear regarding record retention. You'll see it on the web, and hear CPAs buzzing about it..."keep your records for 7 years" etc. etc. While this is great for cleaning out personal filing cabinets, it's downright scary advice for items related to your personal residence. WHY? Glad you asked...
Proving out a sale isn't hard...it's fresh. You probably have the docs close at hand. But that purchase you made 30 years ago...where are those closing documents? And what about that pool you added? The insulation you put in 10 years ago? The new A/C unit you replaced a few summers ago? That kitchen remodel you did a few years back to get more light into the kitchen? No records? Hmm...too bad...because if you can't prove that as part of your cost basis, then you don't get to count that expense against that potential capital gain. That's why I suggest keeping a separate folder for ANYTHING house related - whether you're certain it'll "count" for you come tax time or not. Hang on to it. When you sell...take that folder to your accountant and have them sort out what adds to cost basis and what doesn't. It can mean big savings for you when you do!
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