How to Avoid Capital Gains Tax When Selling Real Estate (2023) - 121 Exclusion Explained

if you're thinking about selling your home and you're wondering to yourself what are the tax implications if I sell well you're in the right place in this video I'm going to cover what taxes you have to pay when selling your home but perhaps more importantly how you can avoid paying taxes on up to five hundred thousand dollars when you do decide to sell the math isn't as straightforward as you may be thinking so continue watching and I'll share my screen with you and I'll cover a few items some of those things are how to properly calculate the gain or perhaps even the loss you would have on your home something called section 121 which is the IRS code section that discusses excluding the gain from a sale of your residence so you don't have to pay income tax uh what if your gain is over the exclusion amount what to do then how much tax will you have to pay in that situation and what if for some reason you don't qualify for the exclusion don't worry I'll still explain and show you what your taxes might be and what you might have to pay and and just how many times can you use the exclusion is there a limit based on your lifespan or how does that work all right so make sure you stay tuned like I said earlier the math behind this is probably not what you're thinking so in a moment I'll share my screen with you and go over an example of how this works but let me first quickly introduce myself especially if it's your first time watching my name is Navi Mirage I'm a CPA that teaches entrepreneurs how to save thousands of dollars in taxes I do that here on social media but I also teach it in an even more comprehensive and easy to understand manner through a course you can find those details on my website which is navimaradcpa.com but for now if you get value out of this video just consider subscribing to the channel or perhaps liking it sharing it with a fellow entrepreneur or someone looking to sell their home okay so let's start off with how to calculate the gain or loss so um let's have a look at this calculation here so how this works is it's your selling price right the price at which your home sold for in this example I'm just saying 650 000 right it's a sale price of your home minus your selling expenses so uh selling expenses are defined by the IRS the biggest one you're going to have likely is commissions paid to a sales person such as a real estate agent as well as some of the legal fees involved there might be other things but um this is what you know is is the biggest chunk of your selling expenses that will end up being what's called your amount realized how much did you actually kind of receive and get in your pocket um so that's what they sort of mean by amount realize okay then what you want to do is you want to calculate what your what's called adjusted basis is for your current um home okay and so um you know don't let that term adjusted basis mess with you it is a tax term but basically your adjusted basis is the purchase price so how much did you pay for your home when you first purchased it you are able to include in the adjusted basis some of your closing costs back when you purchased at home you also get to add to your basis uh improvements such as let's say if you did a full kitchen remodel or a new roof or like a whole new HVAC system or something like that that would be added to your basis as well okay so let's say you bought your home for 350 350 000 that is and you had some closing costs and you did some improvements so now your adjusted basis is four hundred thousand dollars well now we can do the math we have the amount realized minus your adjusted basis gets this in this particular situation at a gain uh calculated at the amount of two hundred and eleven thousand dollars even by the way uh this calculation has nothing to do with the equity in your home right you'll notice there isn't anything in this calculation about what your mortgage balance is or anything like that some people seem to confuse the gain on the sale as the selling price minus their mortgage balance your mortgage or how much you owe uh they don't it's not irrelevant it's not relevant for this right they're irrelevant so for purpose of calculating the gain on sale of home uh exclusion uh don't bother messing with your mortgage or how much you owe or anything like that it has nothing to do with it now what are the exclusion amounts like I said don't worry I'll even if you don't qualify for the exclusion I'll still show you how to calculate this but real quick this is kind of simple if you're filing your tax return as a single person or married filing separately it's 250 000 if you're filing as a married filing jointly then it could be up to five hundred thousand dollars all right so how do you qualify for this exclusion because what I'm saying here is like okay you had a gain of 211 000 but even if you're single you qualify to have all that 211 000 not be taxable uh to you okay so you gotta pass to test these tests are called the ownership test and the use test so let's just read these they're pretty simple if you own the home for at least 24 months so two years out of the last five years leading up to the date of sale you meet the ownership requirement if your tax filing status is married filing jointly only one spouse has to meet their ownership requirement okay so you could have a home and you own that home for at least two years out of the last five years and you could get married at some point in there um it doesn't matter you uh pass the ownership test the use test is the one that's a little bit more restrictive let's read what it says here it says if you own the home and used it as a your residence for at least 24 months of the previous five years you meet the residence requirement the 24 months doesn't have to be consecutive it just has to be 730 days during a five-year period now the next sentence says if married filing jointly and trying to use the full 500 000 exclusion both spouses must meet the use test requirement you can even rent the home for a period of time during the five years and still qualify okay so it's two uh years 24 months 730 days however you want to calculate it out of the last five years and you get a rent at some period in between there that doesn't matter that won't that won't exclude you okay I do want to make a quick note there you see this note here things can get complicated real fast so for example what if your home was gifted to you what if you're widowed what if you had a job relocation what if you had a health related move what if you had what the IRS calls an unforeseeable event um what if you use some of your home for business it messes with this a little bit so just know that there's literally what feels like an infinite number of scenarios so um this may be impacted if you kind of if any of these things ring a bell it could impact you it's basically what I'm trying to say here okay so how much tax would you owe well if you if you look over here tax liability we said that the gain was 211 000 right right here this is the same amount from over here that we calculated well if you qualify for the section 121 exclusion then you don't have to worry about it it's excluded okay the tax rate doesn't matter it's not applicable and the taxes you owe are zero dollars on the sale of your home okay but what if you don't qualify what happens in that situation well if you don't qualify then um it depends on how long you've been in that home okay so if you don't qualify and you've been in the home for one year or less well the tax treatment is as follows you're going to be subject to what's called short-term capital gains tax so um I I have the acronym here stcg in here for short but really what that means is you're going to be taxed at the ordinary tax rates which Falls between 10 and 37 percent depending on your tax bracket okay so what I did is I just kind of put the 24 tax bracket somewhat something here in the middle and the math that's going on here behind the scenes is taking um the two hundred and eleven thousand dollars Mall multiplying it by what your tax bracket might be of 24 percent and I'm getting fifty thousand six hundred forty dollars so that's how much tax you might owe if you had to gain this large and you've only um held that property for one year or less now that's going to be pretty rare right I mean with the exception of what we had here recently in the past few years with this big real estate boom you probably didn't have that much equity in the short period of time now if you don't qualify for the exclusion but you've held that property greater than a year well then you get another tax benefit that is that you get your taxes are the long-term capital gains tax rates okay so these tax rates depend on your income so it could be zero percent which is unlikely given the situation 15 which is what the average sort of person would have and then 20 um so in our example here I'm saying let's use the more favorable 15 tax rate and the taxes owed are 31 000 650 right so there's in a way some tax planning involved here what if you're going to sell your home and you're in there just about uh you know 11 months in a few days right well if you just wait a few more weeks you can save yourself almost twenty thousand dollars in taxes I think it's more like almost nineteen thousand dollars of taxes so a little bit of a tax strategy there some tax planning to do when you are selling your home maybe the strategy is you live there one year out of the past five years maybe you want to go in live there another year and save yourself a bunch of money in taxes okay let me um just show you one quick thing on my screen here and then go over some more of those questions that I said I was going to cover at the beginning of the video I want to show you the tax brackets that um may be applicable just so you can kind of see what I was talking about a moment ago so let me drag this over so I just want to show you what I meant by the tax bracket so these are the 2023 tax tables for single filers so this is what I meant by depends on your tax bracket right 10 up to 37 percent depending on uh your income and then uh if you're married filing jointly you notice that these tax brackets become a lot wider why I chose 24 is that you know I'm assuming your taxable income was within this range but if you make more money you got to pay more tax okay sorry not my rule that's the irs's rules and then I've married filing separately you can see those tax brackets here and there's tax brackets for a head of household as well let me show you the capital gains tax rates all right I was saying like hey it's zero percent 15 or 20 here's why it's like that way depending on your tax filing status and how much income you earn the tax rate can vary so that's why I just said hey if you're married and um you know this is your income then 15 is a reasonable rate to use for our example okay so uh what if your gain is higher than the exclusion amount right so well here's what happens if your gain is over the exclusion amount you'll just have to pay taxes on the amount over and above the exclusion I mentioned earlier okay so you'll pay likely long-term capital gains tax rates on the amount over and above the exclusion okay so let's say you had a gain of 750 000 and um you're married filing jointly so five hundred thousand dollars of that gain is excluded well then two hundred fifty thousand dollars would be subject to the long-term capital gains tax rates uh that you can see right here so that's kind of how that would work all right um can you use the exclusion multiple times yeah you can do that you can use it multiple times there isn't a rule that says you can only use the exclusion once you just have to be mindful that you can't use the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home I know that's a bit of a mouthful basically don't use the exclusion within two years of trying to use it again that's an easier way to say that okay so I just wanted to create this video to explain to you what your tax implications are if you're going to sell your home in a moment here if you're watching on YouTube popping up soon will be another video I recommend based on the fact that you watch this one don't forget to like And subscribe and I'll see you either in the course or in the next video

Channel: Navi Maraj, CPA

Views: 63,814

Keywords: section 121, gain on sale of home, capital gain exclusion

Id: M21Z6_K_sbI

Length: 12min 54sec (774 seconds)

Published: Thu Mar 09 2023