Buying or selling a home is a big decision to make for anyone.
The process can be tedious and stressful, especially if you consider the legal and administrative matters that need to be handled. Taxes are perhaps one of the biggest headaches you will encounter along the way. The last thing you want is to not take advantage of your tax deductibles or run into issues when filing for returns.
Given how tricky taxes can be, it is important to familiarize yourself with how they will factor into real estate purchases and sales. Get to know more about the tax implications of buying and selling a home so that you can manage your records smoothly and avoid issues with the IRS along the way.
Buying a Home
Home ownership can be a huge investment for anyone, given how big of an expense you would have to make. In terms of the tax impact of purchasing a home, there are two main things to remember: transfer taxes and tax deductions.
Governments may charge a transfer tax when property ownership moves from one person to another. The amount will usually be derived from the purchase price, though it may also be calculated based on different factors. Each state, county, or municipality will have its own tax rates and rules, so make sure you look into this before finalizing any purchase.
While transfer taxes can be an added hassle to the process, the good news is that buying a home also makes you eligible for tax benefits, which mostly come in the form of deductions. Similar to other deductible expenses, these benefits allow you to address your taxable income, effectively reducing the amount you need to pay for taxes.
Some of the most common tax deductions granted to homeowners include:
- Mortgage Interest
- Paid Points to Lenders
- Private Mortgage Insurance (PMI)
- Real Estate Taxes
As a homebuyer, it is best to familiarize yourself with Form 1098, also known as the Mortgage Interest Statement, where you detail information related to any mortgage interest that you paid for the year. Likewise, if you are a first-time buyer and have an investment retirement account (IRA), you can qualify for a penalty-free withdrawal even if you are under the age of 59 and ½.
Selling a Home
When it comes to selling a home, you can also expect various tax implications to arise from the sale. Check out the following tax considerations to know about before securing any sale.
Capital Gains and Losses
Capital gains tax is usually charged for the difference between the amount you paid for an asset and the amount you got for selling it. Based on IRS regulations, single taxpayers can eliminate up to $250,000 of their gains while married couples filing jointly can eliminate up to $500,000. However, the exclusion only applies if you—the homeowner—lived in the home for two years minimum within a period of five-years.
Unfortunately, if your sale price is less than how much you acquired your home for, the loss will not count as a deductible.
If you did not meet the conditions needed to qualify for the capital gains exclusion, you can apply for a reduced exclusion for the following reasons:
- Health reasons
- Change of employment
- Unforeseen circumstances, such as multiple births
Generally, if you receive Form 1099-S or do not qualify to exclude all your gains, you will need to report the sale. Form 1099-S, also known as Proceeds from Real Estate Transactions, is usually issued by title companies, closing agents, or mortgage companies. To avoid receiving this form, you must give assurance that your profits are completely tax-free.
Gains essentially refer to any amount in excess of the cost of acquisition for your home. However, for taxation purposes, you would have to calculate adjustments to determine whether you actually incur a gain or loss from the sale. To do this, you need to add expenses from improvements made to your home to the original cost and subtract depreciation.
Take Charge of Your Taxes with the Real Estate Boom
The pandemic has surprisingly led to a seller’s market in real estate. The Twin Cities is experiencing a massive real estate boom, prompting many sellers to put up their homes in the marketplace. With that, understanding how gains from sales are treated in a tax perspective will be crucial to avoiding conflicts and complying with regulations. Still have questions? Not sure how your bottom line might be affected by the purchase or sale of a home this year? Contact Carefree Bookkeeping for a free initial 20-minute consultation.