People who sold their homes in 2023, after living in them for a while and enjoying their low mortgage rates, have seen big gains in their property values. Fortunately, most of these gains won’t be taxed.
If you sold a home in 2023, your lender or broker may give you Form 1099-S. Federal law requires the party responsible for closing your deal (this could be an escrow agent or title company) to send these forms out, filled in with the closing date and proceeds of the sale.
Form 1099-S only needs to be sent to sellers who have taxable gains to report on their 2023 returns. Read on to find out why most home sellers won’t have to report their home sale to the IRS! (You still may choose to report the sale on your return, even if not required.)
If you get the 1099-S, a copy is on file with the IRS. You’ll need to report your capital gains on your federal return. If you want to avoid this, act now. Before February 15, 2024, send a statement to your title agent that all the profit on your sale is excluded from capital gains tax.
Can You Skip Capital Gains Tax, Using the Principal Residence Exclusion?
First, what are capital gains? You take the purchase price your buyer paid for your home. Subtract the agent commissions, appraisal costs, recording and escrow fees. Subtract your cost basis. That’s what you originally paid for the home (including brokerage fees, commissions, recording fees, etc.). Add the price of upgrades you might have made. Now you have a total for capital gains. You would pay capital gains tax only on that amount.
If you owed any.
Whether you sold a home in 2023, or want to sell in the future, you can skip capital gains taxes on profits for the sale of your primary residence, up to $250,000.
Under what provision?
It’s known as the principal residence exclusion. Through this exclusion, the Internal Revenue Service (IRS) lets home sellers keep their profits, up to $250K (if they’re filing singly; it’s $500K for spouses filing jointly).
And you’re entitled to the exclusion every two years.
Note: In this article, we take a look at the federal rules. You’ll still need to check your capital gains tax by state, so put that on your list of tax items to cross off.
The Two-Year Residence Rule Is Firm, Yet Flexible.
What if you’re selling, but haven’t lived in the home for the last two years? Even then, you might not need to pay capital gains tax.
Living in a home any amount of time that adds up to two years out of the recent five-year window gets you the two-year principal residence exclusion. In other words, up to $250K in sale profits is yours to keep tax-free if you lived in the home for at least 24 months of the five years leading up to its sale. Married filing jointly? Then you both needed to live there for the 24+ months, although only one of your names on the deed is all it takes.
Quick Q&A:
- Did you move in and out of the house? That’s fine. The two years doesn’t have to have been just one block of time.
- Have you moved because you were serving the national interest? If you or your spouse are relocated by the military, the Foreign Service, or a federal intelligence agency, you may choose to hold off the five-year lookback time for up to 10 years under the official extended duty provision.
- Did you face an unusual life change in 2023? The two-year minimum occupancy rule is loosened for moves related to a death in the family, inability to pay the mortgage in a divorce, the onset of a physical or mental disability, job-related or unemployment-related moves, or similarly urgent reasons. You may still qualify for the full principal residence exclusion in compelling circumstances.
Publication 523 has the details on the above allowances.
Don’t Meet the 2-Year Residence Requirement? Made More Than $250K in Profits? How Does the Tax Work?
Say you have to sell before accumulating your two years of occupancy. In that case you might still qualify to exclude the percentage that matches the time you were living in the home. For example, if you lived in the home you sold for 6 months of the five years before closing day, then you unlocked one quarter of the full, two-year exclusion. That exempts $62,500 for the individual filer (double that for jointly filing spouses).
Now, say you made more than $250K in profits (or $500K married filing jointly). If you have profits that are not exempt, the IRS will tax them at your rate for capital gains. You use Schedule D to report them. There are two kinds of capital gains tax: short-term, and long-term:
- Have you held the home just a year or less? Short-term capital gains are the sale profits when the deed was held no longer than one year.
- Have you owned the home more than a year? You get taxed at the lower rate that applies to long-term gains.
- Do you earn $44,625 or less? Then as long as you lived in the home for a total of two years out of the last five before you sold, you can qualify for 0% long-term capital gains. (You can earn up to twice that much — $89,250 — if you’re a surviving spouse or a joint filer.)
So, as a general matter, the IRS taxes your sale profits based on how long the deed was in your name before you conveyed it to someone else in your profitable deal.
If your deal was unprofitable, sorry, but no deduction applies for that. Learn more about capital gains and losses from the IRS itself.
Key tip! Rental proceeds are taxed as income tax. But know the 14-day rule if you’ve rented out your home with Airbnb, Vrbo, or the like. You don’t have to report income from short-term rentals, up to 14 days throughout the year, as long as you are staying at the home for 14+ days.
Investment properties generally can’t get the principal residence exclusion. But owner-investors can defer capital gains by investing profits from a current sale directly into the purchase of another investment property. See our Six Steps to a 1031 Exchange.
Capital Gains for Sellers Are Strong in This Market. Know What You Can Exclude!
Too many people pay taxes they don’t have to pay. That’s why we offer this article to our readers. But we cannot give individual tax guidance or legal advice. Always read the federal and state tax IRS instructions in full.
It’s completely normal and helpful for a homeowner to rely on licensed tax experts for advice on offsetting capital gains, appreciation and depreciation, and best reporting practices. So, when in doubt, call your accountant!
Supporting References
AttomData.com: U.S. Home-Seller Profits Continue Rising as Home Values Hit New Highs In Third Quarter (Oct. 19, 2023).
TurboTax, from Intuit: Tax Aspects of Home Ownership – Selling a Home (updated Dec. 27, 2023).
The ClearValue Tax channel (with Brian Kim, CPA from Clear Value Finance) via YouTube: 12 Tax Tips to Cut Your Tax Bill This Year.
Rae Hartley Beck and Doretha Clemon for Investopedia.com: Principal Residence Exclusion – Definition, Amount, IRS Rules (updated Jun. 4, 2023).
Deeds.com: Selling Your Home for a Handsome Profit This Year? Is Capital Gains Tax an Issue? (Jul. 14, 2023).
And as linked.
More on topics: Capital gains tips for home sellers, Tax tips
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