A summary of tax implications from the sale of a primary residence or an investment property.
The sale of a home can generate a Capital Gain if the sale price is higher than the adjusted cost basis. For a primary residence, the adjusted basis is the purchase price plus any home improvement costs and the selling costs. For investment property, this basis is reduced by the total depreciation taken.
Capital Gain exclusion for a primary residence: IRC 121 allows for exclusion of capital gains of up to $250K for individuals / $500K for married filing jointly on the sale of their primary home. You must have lived in the home for at least 2 out of the last 5 years of ownership to qualify.
Transfer of primary residence property tax base for Seniors: California Prop 13 allowed property taxes to remain low by basing them on the original purchase price and not reevaluating them based on the current market value. Prop 60 allows Seniors older than 55 to downsize their home while keeping their original lower property tax, provided the new property value is lower than the old property and the new home is purchased within 2 years of selling the old home. This transfer is only allowed once in your lifetime.
Depreciation recapture for an investment property: Sec 1250 allows taking depreciation on an investment property to reduce your current tax liability. However, when sold, all the depreciation amounts are taxed at 25%. The annual depreciation amount is usually calculated using a straight-line method by taking the building value (as land cannot be depreciated) and dividing it by 27.5 years.
1031 Exchange for an investment property: This allows taxes to be deferred on a home sale by reinvesting the proceeds in another investment property. If the value of the new property is lower, then only a partial exchange is allowed. The new property must be identified within 45 days and escrow closed within 180 days of selling the original property. Deferred taxes include both the Capital Gain and the Depreciation Recapture amount. The adjusted basis of the new property will be reduced by the deferred taxable gain.
The effect of the new TCJA law on tax deductibility is discussed in our blog “TCJA Changes to Real Estate.”
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