If You Sell a House and Buy Another, Do You Pay Taxes?

When you sell a home and purchase another, tax obligations arise. Many people assume they can avoid taxes entirely on a home sale, especially if they reinvest the proceeds into a new residence. Tax implications depend on various factors, including your profit, how long you lived in the home, and your tax filing status. This article clarifies relevant tax rules for homeowners navigating a sale and subsequent purchase.

Understanding Capital Gains and the Principal Residence Exclusion

When you sell your home for more than you paid for it, that profit is generally considered a capital gain. These gains are classified as short-term (assets held one year or less, taxed at ordinary income rates) or long-term (assets held more than one year, taxed at more favorable rates). Internal Revenue Code Section 121 allows many homeowners to exclude a substantial portion or all of their capital gain from taxable income. This is known as the principal residence exclusion.

To qualify for the full principal residence exclusion, you must meet both an ownership test and a use test. For the ownership test, you must have owned the home for at least two years during the five-year period ending on the date of the sale. The use test requires you to have lived in the home as your main home for at least two years during the same five-year period. These two-year periods do not need to be continuous.

The exclusion amounts are up to $250,000 for single filers and up to $500,000 for those married filing jointly. If your capital gain is below these thresholds and you meet the ownership and use tests, you typically will not owe federal capital gains tax on the sale. A reduced exclusion may apply in certain unforeseen circumstances if you do not meet the full two-year requirements.

Calculating Your Home Sale Gain or Loss

Determining your taxable gain or loss involves calculating your adjusted basis and net sale price. Your home’s adjusted basis is its original cost plus the cost of certain improvements and closing costs you paid when you bought it. Examples include the purchase price, abstract fees, recording fees, and title insurance. Significant improvements like adding a new room or replacing the roof also increase your basis.

Repairs, such as fixing a leaky faucet, do not increase your basis. Keeping detailed records of all purchase documents, settlement statements, and home improvement receipts is important for accurately calculating your adjusted basis. This documentation helps support your figures if questioned by the IRS.

The net sale price is the gross selling price of your home minus certain selling expenses. These expenses can include real estate agent commissions, legal fees, title insurance premiums paid by the seller, and staging costs. For example, if you sell your home for $600,000 and pay $36,000 in commissions and $4,000 in other costs, your net sale price would be $560,000.

You calculate your gross gain or loss by subtracting your adjusted basis from your net sale price. If your net sale price is $560,000 and your adjusted basis is $300,000, your gross gain is $260,000. From this, you subtract the applicable principal residence exclusion. For a single filer, the $260,000 gain would be reduced by the $250,000 exclusion, resulting in a taxable capital gain of $10,000.

Other Tax Considerations When Selling and Buying

Beyond federal capital gains, other tax considerations arise during a real estate transaction. Many states impose their own capital gains taxes on real estate sales. These state-level taxes vary significantly, with some states having no capital gains tax and others applying rates similar to their income tax rates. Consider these potential state obligations when budgeting for your home sale.

Transfer taxes, also known as stamp or deed taxes, are often levied by state or local governments when real estate changes hands. These taxes are a percentage of the sale price and can be paid by the buyer, seller, or split between both parties, depending on local practice. For example, a transfer tax might be 0.5% to 2% of the sale price, potentially adding thousands to closing costs. Property taxes are also prorated at closing for both the old and new homes, meaning buyer and seller each pay their share based on ownership days.

When purchasing your new home, several tax deductions may be available. The mortgage interest deduction allows homeowners to deduct interest paid on qualifying home loans up to $750,000 of mortgage debt for loans originated after December 15, 2017. Property taxes paid on your new home are also generally deductible, subject to a $10,000 per household limitation for state and local taxes (SALT) combined. Additionally, points paid to obtain your new mortgage may be deductible over the loan’s life or in the year paid, depending on circumstances.

Reporting Your Home Sale to the IRS

When you sell your home, the closing agent (e.g., title company or attorney) is responsible for reporting the sale to the IRS on Form 1099-S, Proceeds From Real Estate Transactions. You, as the seller, will receive a copy of this form, usually by January 31 of the year following the sale. This form indicates the gross proceeds but does not account for your adjusted basis or exclusion amounts.

If your entire gain from the home sale is excluded under the principal residence exclusion, you generally do not need to report the sale on your tax return. This applies if the gross proceeds on Form 1099-S are less than or equal to the maximum exclusion amount ($250,000 for single filers or $500,000 for married filing jointly), and you did not receive a Form 1099-S. However, if you received a Form 1099-S, even if the entire gain is excludable, you may still need to report the sale on Form 8949, Sales and Other Dispositions of Capital Assets, showing the full exclusion and no taxable gain.

If a taxable gain remains after applying the principal residence exclusion, or if you do not qualify for the exclusion, you must report the sale on your tax return. This involves detailing the transaction on IRS Form 8949. On Form 8949, you will list the property’s description, acquisition date, sale date, sale price, and adjusted basis. The totals from Form 8949 are then transferred to Schedule D, Capital Gains and Losses, where your capital gain or loss is summarized and factored into your overall tax calculation.

The IRS provides specific instructions for completing these forms, and accurately reporting your home sale ensures compliance with federal tax law. Maintaining thorough records of your home’s purchase, improvements, and sale is important for correctly completing these forms and supporting your tax position. These records include closing statements, improvement receipts, and any Form 1099-S you receive.