Author Topic: Trying to understand how capital gains works on a home sale  (Read 2353 times)

lhamo

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Trying to understand how capital gains works on a home sale
« on: January 31, 2015, 11:19:42 PM »
This is somewhat embarrassing to have to ask, but it is a big deal related to our planning, so here goes:

How do capital gains on a home sale work, particularly if you can engineer your situation so that you do not have any (or at least very little) earned income in the year you make the sale?

I understand that there is a $500,000 exclusion from capital gains if you have owned/lived in the home more than five years.  We qualify for that.  Problem is even after taking that exclusion we still will likely have $1,000,000 or more in capital gains that will be eligible for capital gains tax.   Yes, we have a nice big lottery ticket I am hoping we can cash in soon....

Supposedly if you are in the lowest income brackets (10-15%), then there is NO LTCG tax -- see http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States

But is that true even if your capital gains are over the earned income tax thresholds? 

In other words, if I can engineer us having no other income in 2016 (aka both DH and I FIRE no later than Dec 31, 2015), can we then walk away with $1m + tax free from our apartment sale if we sell in 2016?  Am I understanding this right?  Or do the profits from the sale actually go back into calculating our "ordinary income" amount for that year, in which case we would be taxed at 20% on the long term capital gain? 

I know everybody is probably going to say "speak with a tax professional" and most likely we will to make sure we aren't messing things up, but kind of want to get my head around the whole thing first.  I had been figuring a 20% LTCG tax rate on the sale just to be safe -- $200k in tax we don't have to pay might just help me to convince DH to FIRE/sell the apartment sooner rather than later!








GizmoTX

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Re: Trying to understand how capital gains works on a home sale
« Reply #1 on: January 31, 2015, 11:38:57 PM »
From the IRS: "If you have a gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income. You may qualify to exclude up to $500,000 of that gain if you file a joint return with your spouse. Publication 523, Selling Your Home, provides rules and worksheets. Topic 409 covers general capital gain and loss information.
In general, to qualify for the exclusion, you must meet both the ownership test and the use test. You are eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale."

From Nolo: "Your gain is actually your home's selling price, minus deductible closing costs, selling costs, and your tax basis in the property. (Your basis is the original purchase price, plus purchase expenses, plus the cost of capital improvements, minus any depreciation and minus any casualty losses or insurance payments.)"

Earned ordinary income in the 10-15% bracket only eliminates capital gains tax up to the bracket limit, about $33K, not the entire gain. The portion of capital gains over the $33K will be taxed at 15%. If your gain less the exclusion = $1M, then your capital gains tax would be 15% of $999K, or $150K. (I'm rounding for simplicity.)
« Last Edit: February 01, 2015, 12:07:58 AM by GizmoTX »

MDM

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Re: Trying to understand how capital gains works on a home sale
« Reply #2 on: February 01, 2015, 12:12:21 AM »
Earned ordinary income in the 10-15% bracket only eliminates capital gains tax up to the bracket limit, about $33K, not the entire gain. The portion of capital gains over the $33K will be taxed at 15%. If your gain less the exclusion = $1M, then your capital gains tax would be 15% of $999K, or $150K. (I'm rounding for simplicity.)

Check the Form 1040 instructions.  Just after the Foreign Earned Income Tax Worksheet is the Qualified Dividends and Capital Gain Tax Worksheet.  You'll want to get familiar with the latter.  E.g., the top end of your gains will probably be taxed at 20%.  But, all in all, not a bad deal....

lhamo

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Re: Trying to understand how capital gains works on a home sale
« Reply #3 on: February 01, 2015, 01:07:34 AM »
OK, so it looks like the way I was estimating earlier was closer to correct, though it won't be the WHOLE amount that will be taxed at 20%.  That helps a bit.  And I should probably show DH that working into the year that we plan to sell the apartment is not going to be favorable for tax purposes, at least to the extent that his income exceeds what we can put into his 403b. 

Monkey Uncle

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Re: Trying to understand how capital gains works on a home sale
« Reply #4 on: February 01, 2015, 04:25:06 AM »
OK, so it looks like the way I was estimating earlier was closer to correct, though it won't be the WHOLE amount that will be taxed at 20%.  That helps a bit.  And I should probably show DH that working into the year that we plan to sell the apartment is not going to be favorable for tax purposes, at least to the extent that his income exceeds what we can put into his 403b.

Seems like you might be subscribing to a fallacy here.  If your husband works during the year of the sale, you are not going to end up with less money.  Yes, you will pay more in total taxes, but the extra tax will be less than the extra money your husband earns.  You will end up with more money, not less.  If your husband wants to RE and you are financially ready, by all means, do it.  But don't do it because you think taxes are going to cancel out the extra income.