What Happens If You Sell Your House for Less Than You Paid?
Discover the realities and what to consider when your home sells for less than its purchase price, impacting your financial outlook.
Selling your home for less than its original purchase price can be disheartening, raising questions about financial and tax implications. Understanding how this scenario affects your personal finances and tax obligations is important. While a loss on a home sale might seem straightforward, tax rules differentiate between various types of property.
Understanding Loss Deductibility for Personal Residences
When you sell your primary residence at a loss, this loss is not tax-deductible. The Internal Revenue Service (IRS) distinguishes between personal-use property, such as your home, and property held for business or investment purposes. Losses incurred on personal-use assets are considered nondeductible personal losses, and cannot be used to offset other income or capital gains.
This non-deductibility contrasts with the treatment of gains on a primary residence. Homeowners may qualify for a capital gains exclusion, allowing individuals to exclude up to $250,000 of gain and married couples filing jointly to exclude up to $500,000 of gain from their taxable income. To qualify, you must have owned and used the home as your primary residence for at least two of the five years leading up to the sale.
Calculating Your Realized Loss
Even though a loss on a personal residence is not deductible, calculating the loss is important for your records. The starting point for this calculation is your home’s “basis,” which generally includes the original purchase price.
Your basis can be increased by certain expenses incurred during ownership. These “adjustments to basis” include the cost of capital improvements that add value, prolong the home’s useful life, or adapt it to new uses, such as room additions, new roofs, or kitchen remodels. Certain closing costs incurred when you bought the home, like title insurance, legal fees, recording fees, and survey costs, also increase your basis. Conversely, your basis is reduced by factors such as depreciation if any part of the home was used for business or rental purposes, or any insurance reimbursements received for casualty losses.
To determine your realized loss, subtract your adjusted basis from the net selling price after accounting for selling expenses. Selling expenses typically include real estate commissions, advertising costs, legal fees, escrow fees, and transfer taxes. For instance, if your adjusted basis was $300,000 and you sold the home for $280,000, incurring $20,000 in selling expenses, your net proceeds would be $260,000, resulting in a $40,000 loss.
Reporting the Sale to the IRS
When you sell real estate, the transaction is often reported to the IRS by the closing agent on Form 1099-S, “Proceeds From Real Estate Transactions.” This form shows the date of sale and the gross proceeds. While you might receive this form, you generally do not need to report the sale of your main home on your personal income tax return if you meet the criteria to exclude all of the gain.
If the sale does not qualify for the full gain exclusion, or if you received a Form 1099-S, maintain thorough records related to the purchase, improvements, and sale of your home. These records support your basis calculation and transaction details if the IRS requests them.
When Your Home Was an Investment Property
The tax treatment changes significantly if the property sold was an investment or rental property, not your personal residence. For tax purposes, an investment property is held to generate income or appreciate in value, rather than for personal use.
Losses incurred on the sale of investment property are generally deductible as capital losses. These capital losses can first offset any capital gains from other investments during the year. If capital losses exceed capital gains, you can deduct up to $3,000 of the remaining loss against your ordinary income in a given year ($1,500 if married filing separately). Any capital loss exceeding this annual limit can be carried forward indefinitely to offset capital gains or a limited amount of ordinary income in future tax years.
When calculating the loss on an investment property, account for any depreciation claimed during the rental period. Depreciation reduces the property’s adjusted basis, affecting the calculated gain or loss upon sale. Sales of investment properties are reported on IRS Form 8949 and Schedule D, which are part of your annual tax return.