A tax break for the mortgage interest you paid isn’t the only benefit that comes with owning a primary residence. You may also qualify to exclude capital gains when you sell your home. Capital gains tax is what you pay when you sell an asset that has increased in value. When you decide to sell your primary residence and it has increased in value, you’ll be eligible to exclude some of the capital gains from the proceeds of your sale. Currently, the IRS allows taxpayers to exclude up to $500,000 in capital gains if married filing jointly or $250,000 if single.
Let’s say you purchase a home for $200,000. It’s your primary residence and the only home you own. A few years later, you decide to move and sell it for more money. After paying for costs related to the sale, your profit is $50,000. If you meet the criteria for the exclusions, you won’t have to pay capital gains taxes on that profit. The capital gains tax rate is 0%, 15% or 20% depending on your income.
To qualify for the exclusion,
- You must have owned your home for at least 24 months out of the previous 5 years.
- It must have been your primary residence for at least 24 months out of the previous 5 years.
- You can’t have claimed another capital gains exclusion in the past 2 years.
The 1031 Exchange
There is an exception to the capital gains exclusion, and it relates to property that was previously purchased through a 1031 exchange. If you own an investment property and you want to sell it and purchase another investment property, you can defer paying capital gains tax on the sale if you do a like-kind exchange (a 1031 exchange).
During a 1031 exchange, you’re selling one investment property and within a certain period purchasing another investment property that is like-kind.
But what if you eventually move into that investment property and convert it to your primary residence? And then want to sell it? The property that you acquired through the 1031 exchange isn’t eligible for the capital gains exclusion if you sell it within 5 years of purchasing it.
