So, you’re getting ready to buy or sell a house. Many folks just have a basic understanding of the process, which is why one of the most common questions we hear at Cook Martin is:
What are the tax implications of buying or selling a home?
It’s an understandable question, especially considering how complicated the tax system can be. This post will explain the tax situations you need to know about when buying or selling a home.
Buying a Home
Here are the standard implications of buying a home:
What You Can or Can Not Deduct With a Home Purchase
There are many incidental costs associated with buying a home, but many don’t qualify for tax deduction.
1. You can’t deduct your down payment. However, if you have a retirement plan, it is possible to cash it out to fund your down payment. If you’re under age 59 ½ and are a first time home buyer, you will be able to avoid the early withdrawal penalty.
2. You can’t deduct the closing costs. Still, you should keep close track of them when refinancing, because they can be used to get a profit discount when you sell the home. You can also look closely at the escrow settlement statement to find some deductible items, including loan origination fees and property taxes.
3. You can’t deduct the cost of repairs or remodeling. While most construction you do on your new home is not tax deductible, you should keep track of major improvements you make, such as remodels, roof replacements, etc. These can be used to reduce how much you need to pay in capital gains tax when you sell. There may be some incentives for updating your home with energy efficient appliances.
4. You can deduct mortgage interest and property taxes. Mortgage interest and property taxes are Schedule A: Itemized Deductions. The lender will send you a Form 1098 during tax season that outlines how much you paid in interest on your mortgage.
Buying an Investment Property
If you’ve purchased a home as an investment property, the IRS treats it differently. Here are the main points you should know:
- Any rent you receive is considered taxable income
- The property doesn’t qualify for the capital gains tax exclusion
- You can write off many expenses, including repairs, insurance, and maintenance
Buying a Second Home
If you’ve bought a second home and don’t plan on renting it, the mortgage interest you pay is usually deductible.
If you do occasionally rent out the home, you must use it yourself at least 14 days more than 10% of the days it was rented. Any real estate taxes paid for your second home are usually deductible.
Selling a Home
Here’s an overview of the tax implications you should know about when selling a home.
Do I Need to Pay Capital Gains Tax?
The capital gains tax (CGT) is a tax on profits you’ve received from selling an asset that you purchased at a lower cost.
Some homeowners hoping to sell will need to pay this tax. However there are many qualifications and exemptions you should know about:
- Single owners: If you’re a single home owner, you won’t need to pay capital gains unless your profit was greater than $250,000
- Married owners: If you are married and own the home jointly, up to $500,000 of your profits can avoid taxation. Your tax rate is usually about 20 percent.
- Time in home: CGT is only required if you’ve lived in your home under two years. If the home has been your primary residence for longer, there’s no tax liability.
- Special circumstances: If extenuating circumstances have prevented you from meeting the two-year requirement, you may still qualify for a full exclusion. Examples include job relocation, divorce, and the death of a spouse.
If you do have to pay the CGT, plan on scheduling a consultation with your tax professional before filing. They can help you itemize all the qualified costs associated with buying and owning the property, which you will then be able to subtract from what you owe.
If you have any questions about the tax implications when buying or selling a house or anything else related to taxes, feel free to contact us and ask.