Warning: this post was written in 2010. As of 2021, it’s still valid information. As always, consult a tax advisor before making any decisions.
A visitor to this website asks the following question:
I bought my house almost 4 years ago for $50,000, put $10,000 in it for improvements. If I sell it for $72,000, and don’t purchase another house, just rent, what are the pros and cons of that?
There is good news here, tax-wise. A single person selling a home can exclude up to $250,000 of the gain on the sale (meaning, you don’t have to pay tax on the gain). A married couple filing a joint return can exclude up to $500,000 of the gain. It doesn’t matter what you do with the money from the sale; you just have to meet the following two tests:
1) In the last 5 years, you must have owned the house for at least 2 of those years.
2) In the last 5 years, you must have lived in the house (meaning, used as your primary residence) for at least 2 of those years.
If a person does not meet the above two tests, they may still be eligible to exclude a pro-rated portion of the gain, provided they meet certain other requirements. Based on the information provided, it appears our questioner fully meets both of the above tests, so the entire exclusion would apply.
Their basis in the property is $50,000 purchase price + $12,000 improvements = $62,000.
In this case, if the house is sold for $72,000, they would have a $10,000 gain. Since this sale qualifies for the $250,000 exclusion, they would not be taxed on that gain. And because the entire gain is excludable, the sale would not need to be reported on their tax return.
The situation can become much more complex if you don’t qualify under the above two tests, or if you do qualify for the above two tests but also used the house as a rental property part of the time, or if you have used part of your home for business purposes and taken tax deductions, or any number of other “what if” scenarios.