Home values skyrocketed all across the Bay Area during the pandemic. It is not uncommon to see homeowners walk away with a huge gain after selling their homes. And while that gain is wonderful, you’ll need to be prepared to pay the income taxes associated with your sale to your state and federal government. In states like California, you have both state and federal income taxes but in states like Washington, you do not have to worry about personal income tax.
Here Is the Good News
Thanks to Section 121, if you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse. And unlike a 1031 exchange which is a “tax deferment” on real estate investments – Section 121 is a set “tax exclusion”.
What Is a Capital Gains Tax?
Capital gain is when a property or asset increases in value. A capital gains tax is the fee you pay on the profits made from selling that asset. Capital gains taxes can apply to securities and tangible assets — real estate, cars and boats. The IRS and many states assess capital gains taxes on the difference between what you pay for an asset (your cost basis) and what you sell it for (your sale price)
We like using the 2022 Smart Asset Capital Gains Tax Calculator to establish estimates. Click HERE to check out the calculator. Please note, we are not tax professionals so we always recommend working with your tax professional when establishing exact tax fees and payments.
You Must Have Used the Home As Your Primary Residence for 2 Out of the Last 5 Years
Now, this doesn’t mean you have to own the property for 5 years. You can live in the home for a minimum of 2 years and still qualify. But the 5 years comes into play because your 2 year time limit doesn’t have to be consecutive. This is awesome for homeowners who have decided to rent out their home for a period of time during their ownership and still want to take advantage of this savings.
Here Is an Example:
You buy a home in Tiburon, California and you use the home as your primary residence for 2 years. You get an opportunity through work to move to London for 1.5 years. During the time you are away you rent out your home. When you return from London you decide to move back in but decide it is time to sell. You can still take advantage of Section 121 because you utilized the home as your primary residence for 2 out of the last 5 years!
Only Applies to Primary Residences
Section 121 only applies to primary residences and does not extend to investment or vacation properties.
No Age Requirement
Unlike the other tax sections we have highlighted in the past there is no age requirement when taking advantage of section 121.
You Can Only Use This Exclusion Once Every 2 Years
Even if you owned two homes and utilized them as your primary residences at different times over the course of 5 years (2 years in one home then 2 years in the other), you can only use this exclusion once every 2 years.
Other Taxes Associated With Your Home Sale Still Apply
Section 121 is associated with your capital gains tax from the sale of your home. This is considered an income tax because the tax is based on the income you gained from the sale of your home. But it is important to note that section 121 does not apply to your property taxes, transfer tax, etc.
We love when we see our clients save money and take advantage of tax savings! But it is important to remember that we are not tax professionals. You should always consult your CPA for official tax advice.
Interested in learning more about tax saving benefits? Click HERE to check out our recent blog post highlighting Proposition 19.
Torben Yjord-Jackson – Realtor
CA License # 02050831
WA License # 22013848
Alicia Magdaleno – Realtor
License # 02065283