Dear Miss Money Matters,
We are selling our apartment, which we haven’t lived in for 10 years. If we use the proceeds to buy a house within a year of the sale, will we still have to pay capital gains tax on the profit since it hasn’t been our primary residence for 10 years? We moved out because we planned on having children but that took longer than expected, and then we moved to California, so we never owned another piece of real estate beside the apartment.
– Joyce F., Maplewood, N.J.
Selling an apartment or house you haven’t lived in can have different tax consequences from selling a home where you have been living. Unfortunately, the tax law doesn’t treat your situation as generously.
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In general, gain from the sale of real estate is subject to federal income tax because that gain is considered income. However, most homeowners can escape paying taxes on a home sale thanks to an exception in the tax code. “Section 121 allows a single taxpayer to exclude up to $250,000 of gain from the sale of the taxpayer’s principal residence,” said Maddie Schueler, a tax consultant with Kentucky-based accounting firm Dean Dorton Allen Ford, PLLC. “The exclusion is increased to up to $500,000 for married taxpayers filing jointly.”
To qualify for the exclusion, you must satisfy an ownership test and a use test, Schueler said.
- You must have owned and used the property as your principal residence for at least two years during the five-year period ending on the date of the sale.
- You can only claim the exclusion once during any two-year period.
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Unfortunately, it doesn’t seem like you meet the qualifications for this exclusion. “If the taxpayers have not lived in the property at all during the ten years prior to the date of sale, they will not qualify for the Section 121 exclusion because they do not satisfy the use test,” Schueler said.
That means any gains on the sale of your property will be subject to federal income tax. But there is some good news. “Because the taxpayers have owned the property for more than a year, however, the gain on the sale will be a long-term capital gain, which is taxed at a more favorable rate than ordinary income,” Schueler said.
The gain on the sale of property is the difference between the amount realized on the sale and the basis in the property. Generally speaking, the basis is the amount paid for the property when you bought it. However, Schueler said you can add the cost of any improvements you made to the property to the basis — which can help decrease the gain on the sale.
“Also, certain selling costs, such as real estate agent commissions, can be subtracted from the amount realized,” she said. “This reduces taxpayers’ gain from the sale, which results in lower federal income taxes.”
To ensure you report the gain from the sale of your home correctly, contact an accountant or tax attorney about your specific circumstance. “Although the recently enacted Tax Cuts and Jobs Act did not change the rules regarding exclusion of gain from the sale of a principal residence, changes in the tax laws are frequent and can have a major impact on a taxpayer’s liability,” Schueler said. “Professional tax advisors track these changes and can help guide taxpayers through the complexity of the Internal Revenue Code.”
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Life + Money columnist Cameron Huddleston answers your money questions, drawing from her more than 15 years of experience as a personal finance journalist, as well as advice from financial experts. If you have money questions, send them to firstname.lastname@example.org with the subject line Dear Miss Money Matters.
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