Home sellers enjoy a tremendous tax benefit upon resale. Internal Revenue Code Section 121 authorizes an “exclusion” — escape from income taxes — for profits from home sales. The exclusion is as much as $500,000 for married couples who file joint returns, and $250,000 for single filers and couples who file separate returns.
How are Home Owners Taxed On Profits Above the IRS Exclusion?
What happens, though, when the gain is greater than the exclusion ceiling of $500,000 or $250,000? Answer: The excess is taxed as a long-term capital gain at a maximum rate of 15 percent, plus applicable state taxes.
The key requirement: Own and live in the property as your principal residence for periods aggregating at least two out of the five years ending on the sale date, and at least two years must have elapsed since you last used the exclusion.
What About Tax Breaks for Personal Property?
When you sell, be mindful of special rules for furniture. The exclusion break does not apply to any furniture or other personal property you might sell for a profit. Count any profit on those items as reportable income in the year of sale. Worse yet, you cannot deduct any loss on their sale, as you did not originally buy them to make a profit or earn income. Nor can you reduce the profit from the sale of a home by a loss suffered from a sale of furniture; the furniture sale is a separate transaction.
If you do decide to sell the contents of your dwelling, the tax can run unexpectedly high. The Internal Revenue Service measures gain or loss separately for each asset sold — not by the overall result of the sale. Thus, even if a lump-sum sale results in a net loss for you, the feds can create a taxable gain simply by disallowing losses that were sustained on some of the assets involved. Result: The taxable gain may far exceed the net dollar gain from the sale.
To illustrate, Rita Harrison’s household contents include some items now worth less than their original cost, while others have substantially appreciated — oriental rugs, for instance. Rita receives $50,000 for household contents, whose original cost might be at least that or more. Nevertheless, she is liable for a capital-gains tax on each item sold for more than cost, with no offset for losses on items sold for less than cost. So if Rita reaps profits of $25,000 and suffer losses of $25,000, she must pay taxes on all profits and ignore all losses.
IRS regulations spell out how Rita is supposed to determine when furniture and appliances count as part of her home. Rita can add to her home’s basis what she spends for furniture, appliances and similar items that are considered fixtures (permanent parts of the property) and, therefore, part of the home. She cannot add to its basis the cost of items that are considered personal property and, therefore, not part of the home.
The law of the state in which her home is located determines whether, say, a refrigerator should be classified as a fixture (which means the item has to be sold with the home) or as personal property (meaning it does not have to be sold). As a general rule, the law considers an item that is easily movable to be personal property, not a fixture.
Julian Block, an attorney in Larchmont, NY, has been cited by media as a "leading tax professional."
At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.