If you're fortunate enough to make more than $250,000 on a Manasquan, NJ home you bought and lived in, you might be liable for some tax when you sell it. But many people believe that it's actually a small price to pay.
However, the truth is that it's rare for a person to actually realize a quarter of a million dollars in true profit from a home sale, even a luxury or waterfront home; and couples are authorized double that amount, $500,000. Even if you are liable for payment on long-term capital gain of more than half a million dollars, the 20 percent top rate on the difference is probably worth it.
Defining the Capital Gains Tax
American citizens are subject to income tax on money they earn, both from employment and investment. Profit on investment is classified as a short (one year or less) or long-term capital gain, and the tax rate differs. Anytime you buy something—antiques, goods, stocks and bonds or real property—with the intent of selling it at some point in the future, you are investing, and you should expect to pay tax for your good fortune.
Under former IRS regulations, owners who sold a home for profit were authorized a once-in-a-lifetime tax exclusion of $125,000, but only after reaching age 55 or older.
The Taxpayer Relief Act of 1997 laid down new ground rules, making it much more financially advantageous for those who sell a primary residence. It is one of the primary reasons many people today view home ownership as a wise financial decision, along with the annual income tax deductions based on mortgage interest and property tax payments.
There are some regulations to keep in mind. however.
How the Exclusion Actually Works
The primary requirement is that, in order to qualify, a home must be a primary residence for at least two of the last five years. In actual practice, and if you don't mind moving, it's possible to take advantage of the exclusion every 24 months, because it's based on the property closing dates, rather than calendar years.
The years of occupancy do not have to be consecutive, but the rules specify that you can take advantage of the exclusion only once every two years. If you own two homes and live in each of them for two years during a five-year period, you cannot sell both the same year and claim the exclusion on both of them.
There is no requirement for reinvesting the proceeds of a home sale in other property; you are free to spend your profits on a long vacation, invest it in another manner, or squander the money, as you wish.
The exclusion is based on the actual sales price of the property, plus any costs of the sale, including commission and closing costs, minus the actual purchase price. Original loan origination and closing costs as well as the actual dollars paid for property improvements during your period of ownership also become part of the cost figure. These become your adjusted cost basis.
You can sell a primary home and then move into a previously-owned vacation home in an area like Chadwick Beach and declare it your new primary residence. However, today you might be liable for payment of capital gains tax on the portion of profit attributed to the time it was a "second home." A tax bill passed in 2005 added some additional regulations for second homes. It's wise to check with a tax adviser if you own more than one home.
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