How Does Selling a House Affect Taxes?
Understand the tax implications of selling a house, including potential exclusions, deductible expenses, and reporting requirements for compliance.
Selling a house can have tax consequences, depending on factors like how long you’ve owned the property and whether it was your primary residence. The IRS may require you to report any profit from the sale, but there are exclusions and deductions that could reduce or eliminate your tax liability.
Capital Gains Exclusion
Homeowners who sell their primary residence may qualify for the IRS Section 121 exclusion, which allows individuals to exclude up to $250,000 of gain from taxable income, or $500,000 for married couples filing jointly. To qualify, the seller must have owned and lived in the home as their primary residence for at least two of the five years before the sale. These years do not need to be consecutive, offering flexibility for those who rented out the property for a period.
A partial exclusion is available for sellers who do not meet the full residency requirement due to circumstances like a job relocation or health issues. For instance, a single homeowner who lived in the property for one year before selling due to a job transfer could exclude up to $125,000—half of the full exclusion.
Non-Qualified Property Treatment
If a home does not meet the criteria for the capital gains exclusion, any profit from the sale is taxable. This applies to second homes, investment properties, or residences not used as a primary home for at least two of the past five years. Instead of benefiting from the exclusion, sellers must report the full gain and pay taxes based on how long they owned the property.
For homes held more than a year, the gain is taxed at long-term capital gains rates, which range from 0% to 20% depending on income level. If the property was owned for one year or less, the profit is taxed as ordinary income, which can result in higher liability.
If the home was used as a rental, depreciation recapture rules apply, meaning the seller must pay a 25% tax on any depreciation deductions previously claimed.
Special rules apply to properties converted from rental use to a primary residence. Only the portion of time the home was a personal residence qualifies for the exclusion, while gains attributed to rental use remain taxable. Properties acquired through a 1031 exchange and later converted to personal use must meet specific IRS guidelines before becoming eligible for any exclusion benefits.
Deductible Selling Expenses
Certain costs associated with selling a home can be deducted from the sale price when calculating taxable gain.
Real estate agent commissions, typically 5% to 6% of the selling price, are the largest deductible expense. Other qualifying deductions include legal fees, escrow charges, and title insurance costs, as they are necessary for completing the transaction.
Advertising and staging expenses, such as professional photography and online listings, also qualify as deductible selling expenses. Home inspection fees and appraisal costs paid by the seller are deductible if they were necessary to facilitate the sale.
Reporting Gains and Losses
Sellers must calculate and report any taxable gain on their federal income tax return. This begins with determining the property’s adjusted basis, which includes the original purchase price plus qualifying capital improvements. Renovations such as a new roof or kitchen remodel increase the basis, reducing taxable gain. Maintenance costs, like painting or minor repairs, do not qualify.
The final sales price, minus deductible selling expenses, is compared to the adjusted basis to determine the total gain or loss. If the gain exceeds the available exclusions, the seller must report it on Schedule D and Form 8949, which provides a breakdown of the sale.
If the property was used for both personal and business purposes, such as a home office, the portion allocated to business use must be separately accounted for. Any depreciation previously claimed for business use may be subject to recapture.
State and Local Requirements
Home sellers must also consider state and local tax laws, which vary widely. Some states impose their own capital gains taxes, while others have no income tax. Certain municipalities levy transfer taxes or recording fees that can affect the final proceeds from the sale.
States like California and New York tax capital gains as regular income, meaning high earners could face rates exceeding 10%. In contrast, states such as Texas and Florida do not tax income, eliminating state-level capital gains tax liability. Some jurisdictions require sellers to withhold a portion of the proceeds at closing if the seller is a nonresident.
Record Retention for Compliance
Maintaining proper documentation is necessary for substantiating tax calculations and ensuring compliance with IRS regulations. Sellers should retain records related to the home’s purchase, improvements, and sale for several years after the transaction.
The IRS generally recommends keeping records for at least three years after filing the tax return that reports the home sale. However, if a seller underreports income by more than 25%, the statute of limitations extends to six years. Documents such as closing statements, receipts for renovations, and property tax records should be organized and stored securely. Digital copies provide additional security against loss or damage.