Capital gains and your home sale
"Then you compare that basis amount to what you get from the sale, less your commissions and other expenses," says Trinz. "When you subtract your cost basis in the residence, this will give you the amount of gain on the sale."
In most instances, sellers will find they made a nice profit, but not one large enough to trigger a tax bill. Some, however, could find their residences appreciated so much that the great sales prices they got ended up costing them at tax time. That's why it's important to accurately track anything that could affect your home's cost basis.
The improvements increase your basis, so a smaller portion of the selling price would be viewed as gain. Any overage is taxed at the applicable long-term capital gains rates, which under the American Taxpayer Relief Act approved Jan. 1, 2013, is 20 percent for higher-income taxpayers, 15 percent for most individuals and, for some sellers, zero percent.
Partial exclusion still a good deal
Even if you don't meet all the home-sale exclusion tests, your tax break might not be totally lost.
When an owner sells a house because of special conditions, such as a change in health, employment or unforeseen circumstances, he or she is eligible for a prorated tax-free gain.
In such a case, the seller first calculates the fractional amount of time that he or she met the two-year use test. For example, a single homeowner is transferred to a job in another city and sells after being in the home for only a year and a half. That would be an occupancy period of 18/24 or 0.75, the number of months lived in the home divided by 24, the number of months in the two-year occupancy requirement. By multiplying the full $250,000 exclusion amount by 0.75, the seller would be eligible to exclude a sale gain of up to $187,500.
Special rules for special circumstances
Members of the military also get special home-sale consideration. Because of redeployments, soldiers often find it hard to meet the residency rule and end up owing taxes when they sell.
But a law change in 2003 exempts military personnel from the two-year use requirement, for up to 10 years, letting them qualify for the full exclusion whenever they must move to fulfill service commitments.
Another law change, this one beginning in 2008, takes into account the special circumstances that a homeowner faces when selling after a spouse dies.
Previously, to exclude the full profit amount allowed married homeowners when they sell, the surviving spouse had to sell the property in the same tax year that the husband or wife passed away. But now, an unmarried widow or widower has up to two years to sell the home and not face taxes on up to $500,000 in profit.
So quit worrying about taxes when you put your house on the market. Chances are good that Uncle Sam won't be able to lay any claim to your hefty home-sale profit.