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Q:

I live in Florida. I paid $167,000 in cash for my home in 2005. There is no mortgage on my home. My home is currently valued at $320,000. If I sell and move into an independent living community, do I have to pay capital gains on $153,000 profit?

A:

First, we want to applaud you. You’re considering making a big change in your life and you’re facing its financial impacts head on. We know that taxes can be tricky, and all of us can easily have blind spots when it comes to our own finances. The good news is you don’t have to do this all on your own.��

Meet with a tax professional along with your financial planner to fully understand the tax consequences of your home sale and of this new chapter of your life, as a whole. Before that, we’ll highlight some key tax considerations of a home sale to prepare you for the conversation. Consider this the movie trailer before you see the movie.

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The 2/5 tests for helping to avoid real estate capital gains

It seems you’re expecting a nice gain on your home sale. You’re not alone. The median home sales price rose nationally by more than 25% between 2019 and 2024, according to government data.����

So, let’s start off with potential good news. Based on the information you provided, you may not owe any taxes on either the federal or state levels on the gain you expect. But that’s only if your profit or “capital gain” is beneath $250,000 and you meet IRS criteria.��
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The IRS excludes up to $250,000 in capital gains on home sales for individuals and up to $500,000 for married couples who file jointly. That’s on the federal level. On the state level, your state of Florida does not have income taxes, so capital gains will not be taxed by Florida either. (Note that capital gains state tax can vary by state.)

To be eligible for some or all of the IRS home sale tax exclusion, you need to pass ownership and use tests that we’ll call the “2/5 tests”:��

• You have used (lived in) and owned your home as your primary residence in two of the last five years before the sale of the home.
• You can meet the ownership and use tests during different two-year periods if they both fall within the previous five years.
• If you excluded a gain from a home sale in the last two years before the current home sale, then you can’t exclude this gain.

REMINDER: Passing the 2/5 tests only means you’re eligible for some or all of the sales exclusion. If you didn’t use the home as a primary residence 100% of the time you owned it, it’s possible that your entire gain may not be eligible for the maximum exclusion, just a part of it, even if you pass all the tests.

The 2/5 tests mean that “timing, timing, timing” can be just as important as “location, location, location” in real estate.

Timing may apply in different ways. For example, let’s say you’re married. Only one of you needs to have owned the house for two of the past five years. However, both of you need to have lived in the house for at least two of the years to be eligible for the $500,000 gain exclusion.

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Cover your tracks��

Because you plan to move from this home into an independent living facility, it sounds like it may have been your primary residence. Even if you satisfy the rules, you still may have associated tasks to complete.��

If the gain is less than the $250,000 (or $500,000 for married couples) allowed, the gain doesn’t need to be reported on your federal return unless you receive a 1099-S form, which may or may not happen after closing. Receiving the form does not mean you owe any taxes, but it does mean you would need to report the sale as part of your federal return.

Whether you receive the form or not, IRS audits happen. Save all documentation that shows you passed the 2/5 tests, such as previous tax returns and the title and share that with your tax professional.

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What happens if you don’t qualify for the home sale tax exclusion?

Whether you meet the 2/5 criteria or not, there are other ways you can decrease the tax on home sale gains.��

The costs of any home improvements that were part of a larger restoration can be added to the original cost of your home (the cost basis), thereby decreasing the gain and any potential capital gains tax.

What qualifies as a home improvement? The costs of renovating your kitchen or bathrooms, a new heating system or garage would be examples. Ongoing maintenance typically doesn’t count, like replacing a bedroom door. But, replacing all the doors of the house, including the entryway and backdoor, as a home renovation project may count.

Another trick: You can add certain settlement costs to increase the cost basis of your home. These include title insurance, legal fees and transfer or stamp taxes.

By the way, if you already used tax credits related to energy-saving home improvements like a solar energy system, then you can’t add them to your cost basis as a way to decrease your gain. You actually need to deduct them from your cost basis.

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Did you use your home for rent or business?

You didn’t mention if you rent out a part of your home or use it for commercial purposes. Given today’s cost of living and business expense, both are popular these days.

There may be a misconception that using part of your house for business or for rent will help ease potential capital gains when selling your home. Not so. If you did either, only the gain that can be allocated to the residential portion can be excluded from tax. The calculation required to determine the allocation is another reason you want to consult a tax professional.��

Putting aside in-depth calculations, the points we raised should help you explore a tax strategy for your home sale. A new chapter like yours can be exciting, and there are other financial impacts to consider, so give your financial planner a call.��

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WE HOPE YOU’VE FOUND THIS INFORMATION HELPFUL ��

Remember that any financial guidance must be adapted to your unique circumstances, so consult your financial planner and always involve your tax professional for tax questions. In the meantime, keep those questions coming!��