Selling your home is all about timing. For many, the summer home sale season presents a great opportunity. On the flipside, it may seem like a great time to purchase with today’s relatively low interest rates. However, from a tax standpoint, there are several factors to consider. Natalie Simmons, CPA, takes a look at how the recent tax law changes may affect how you buy and sell homes.
You might be in a rush to buy or sell a home before summer starts or interest rates increase even more. But, first, it's important to review the tax rules related to home sales and deductions for mortgage interest, property taxes and work-related moving expenses. Beware: Some rules have changed under the Tax Cuts and Jobs Act (TCJA).
|
Average Mortgage Interest Rates
Source: Freddie Mac Weekly Mortgage Survey |
Timing Counts
Spring and early summer are generally the optimal times to put your house on the market and shop for a new home. Why? The timing coincides with the school year — even if you don't have school-aged children, this may be an important issue for the people on the other side of the negotiating table.
Plus, moving is generally easier when the weather is mild. And closing before fall leaves plenty of time to settle into your new digs and complete any desired renovations before the holiday season begins.
Rising mortgage interest rates may be another incentive for some home buyers to act sooner rather than later. Though rates are still relatively low compared to historical levels, they've been increasing since 2016 — and that trend is expected to continue in 2018. From December 31, 2017, to April 26, 2018, the average interest rate on a 30-year mortgage has increased more than a half percentage point (from 3.95% to 4.58%). (See "Average Mortgage Interest Rates" at right.)
Good News on Home Sale Gain Exclusions
Before you talk to a realtor or get pre-approved for a loan, however, it's important to think about taxes.
For example, you might be selling a house that's increased substantially in value from when you bought it. Fortunately, the new tax law retains the home sale gain exclusion. If you qualify for this tax break, the profit from selling your principal residence will be free from federal income taxes (and possibly state income taxes, too).
The gain exclusion rules are fairly straightforward for most sellers. An unmarried homeowner can potentially sell a principal residence for a gain of up to $250,000 without owing any federal income tax. If you're married and file jointly, you can potentially pay no tax on up to $500,000 of gain. To qualify, however, you generally must pass two tests.
1. Ownership Test. You must have owned the property for at least two years during the five-year period ending on the sale date.
2. Use Test. You must have used the property as a principal residence for at least two years during the same five-year period (periods of ownership and use need not overlap).
To be eligible for the maximum $500,000 joint-filer exclusion, at least one spouse must pass the ownership test, and both spouses must pass the use test.
If you excluded a gain from an earlier principal residence sale under these rules, you generally must wait at least two years before taking advantage of the gain exclusion break again. If you're a joint filer, the $500,000 exclusion is only available when neither you nor your spouse claimed an exclusion for an earlier sale within two years of the sale date in question.
Important: If you make a "premature" sale that happens less than two years after an earlier sale for which you claimed an exclusion, don't give up hope. There's a favorable exception that might help: You can claim a reduced (prorated) exclusion if your premature sale is primarily due to:
- A change in place of employment.
- Health reasons.
- Certain unforeseen circumstances outlined in IRS regulations.
If you qualify for the reduced exclusion, it can be generous enough to completely shelter your profit from federal income tax.
For example, let's say you and your spouse own and use a home as your principal residence for 18 months. You're forced to sell because your job is transferred to a distant state. Under these circumstances, you would qualify for a reduced gain exclusion of $375,000. This is 75% of the full $500,000 joint-filer exclusion, because you owned and lived in the home for 75% of the required two-year period.
Bad News on Home-Related Deductions
The TCJA also contains some unfavorable provisions for homeowners and people who relocate for a change in their place of employment. Specifically, for 2018 through 2025, the new law:
- Limits the deduction for state and local taxes to $10,000 ($5,000 for separate filers) for the sum total of state and local property taxes and state and local income taxes (or sales taxes if you choose that option),
- Reduces the mortgage "acquisition debt" limit for the home mortgage interest deduction, to $750,000 ($375,000 for those who use married filing separate status) for newly purchased homes,
- Eliminates the deduction for interest on home equity debt, unless it's "acquisition debt" that's used to buy, build or substantially improve the taxpayer's home that secures the loan and meets other requirements,
- Eliminates the above-the-line moving expense deduction (with an exception for members of the military in certain circumstances) for people who relocate for work-related reasons, and
- Suspends an employee's ability to exclude from taxable income the value of employer-provided reimbursements for moving expenses (with an exception for active-duty military personnel in certain circumstances).
These temporary provisions are set to expire on January 1, 2026, unless Congress extends them. In the meantime, the changes could adversely affect property values and the demand for expensive homes and homes in jurisdictions with high property taxes.
As buyers learn about these provisions, some properties may take longer to sell than under prior law. And, as banks adjust their underwriting standards to reflect the new tax rules, some buyers may no longer earn enough income to qualify for "jumbo" home mortgages.
Ask the Experts
Timing is just one consideration when buying or selling a home. It's important to consider tax matters, too. The tax rules for the federal home sale gain exclusion and home-related tax deductions can get complicated in some situations. Whether you're buying your first home, upgrading to a larger home or downsizing for retirement, discuss matters with your tax advisor before negotiating a deal.
There are significant tax implications when it comes to buying and selling your home. Unfortunately, I’ve run across many people who are simply unaware of how the tax laws affect home transactions. Gone are several key deductions that home buyers and sellers were accustomed to in years past. Even with the new Tax Cuts and Jobs Act (TCJA) in place, individuals can still avoid an unexpected tax bill with the proper planning.
Perhaps the biggest way individuals are affected by these IRS regulations is the potential for taxation on the gains from their home sale. While this isn’t new, many people don’t consider the two-year homeownership and two-year residence tests that must be met in order to benefit from the home sale gain exclusion.
The recent TCJA changes add some wrinkles to this process as well. The mortgage acquisition debt limit has been reduced and the deduction for home equity interest has been eliminated entirely (except for acquisition indebtedness). On top of that, moving expenses are mostly a thing of the past along with employer-provided reimbursements. For our clients, I think the biggest change the TCJA brings is the new limitations placed on the state and local tax deduction for property taxes paid. It’s really a sizable change that could affect many taxpayers.
I highly encourage our clients to discuss their plans prior to making any major real estate transactions. With 415 Group’s proactive approach, we’re able to examine how these changes impact your total tax picture.