Homeowner Tax Exclusions

Homeowners receive a capital gains tax exclusion when they sell their home.  Up to $250,000.00 in gain is exempt for a single owner.  If a married couple files jointly, the exclusion is $250,000.00 per person or a total of $500,000.00 is exempt from tax on any gain.

The homeowner must have lived in the house two out of the last five years, prior to the sale, to qualify.

You should also be aware of the possibility of qualifying for a “stepped up basis”.  You may qualify for a “stepped up basis” upon 1) a spouse’s death or  2) by inheriting a property after the owner dies.

If you are married and own a property together, and the title is held as community property, when one spouse dies the surviving spouse automatically receives the decedent’s half interest in the property and a new “stepped up basis” at 100% of the value of the property at the time of death.   Both halves of their community property are “stepped up”.  The same would be true for any other assets that have appreciated in value.  With rental property the surviving spouse is able to depreciate the building based up on its new stepped up value.  If a property is inherited, 100% of the property’s value at the time of death is the new basis for both depreciation and capital gains calculations.

A very simple example is if a person originally purchased a home for $100,000.00 and sells it years later for $900,000.00 they would have an $800,000.00 profit or gain.  If they lived in the house for at least two out of the last five years they would have either a $250,000.00 exclusion for a single person or a $500,000.00 exclusion for a married couple.   If the profit on the sale of the house was $800,000.00 and you have a $500,000.00 combined exclusion, you would  have a $300,000.00 gain above the exclusion.  You would be responsible for paying tax on that $300,000.00 balance received.

However, if you receive a “stepped up basis” due to a spouse dying, or inheritance, the value of the property is established at the exact time of death.  On a home that was originally purchased for $100,000.00 and at the time of a spouse’s death the home’s value is $650,000.00, the basis for tax purposes becomes $650,000.00. If you sell the home now for $900,000.00 you only have a gain of $250,000.00 ($900,000.00 less the $650,000.00 basis). The $250,000 individual exemption would exclude this gain from any taxes. The stepped up basis can save you a lot of money at tax time.

The IRS rules concerning the sale of inherited property are quite involved and can be complicated.  We are not tax experts and are not qualified to give tax advice. It is important that you always get professional tax advice from your accountant or tax attorney.

This article was originally written for and appears in the San Francisco Examiner. Eric Ruxton and Larry Aikins are the owners of Terrace Realty Inc. and Terrace Associates Inc., in Redwood City. Terrace has been in business for 60 years and in addition to being an independent Brokerage Company, also owns and operates rental properties.