How to Avoid Paying Capital Gains Taxes When You Sell Your Home (Part 2 of 3)
Once you calculate your capital gains when you sell your home, the next step is figure out how to avoid paying capital gains taxes when you sell your home.
Capital Gains Tax Exclusion on the Sale of Your Home
You probably know that, if you sell your home, you may exclude up to $250,000 of your capital gain from tax. For married couples filing jointly, the exclusion is $500,000. Also, unmarried people who jointly own a home and separately meet the tests described below can each exclude up to $250,000.
The law applies to sales after May 6, 1997. To claim the whole exclusion, you must have owned and lived in your home as your principal residence an aggregate of at least two of the five years before the sale (this is called the ownership and use test). You can claim the exclusion once every two years.
However, even if you have built in gains in your home that exceed the exclusion amount, you may be able to eliminate those gains.
Avoid Capital Gains with a Step Up in Basis
Many people don’t know that when you die, the basis in your assets, including your home, receives a new basis equal to the fair market value at death. This is best explained by the following example:
Let’s assume that you purchased a home in 2001 for $500,000. Now, in 2014, your home is worth $1,200,000, so that you have built in gains of $700,000. If you sold your home in 2014, you would have $700,000 in capital gains and you would have to pay taxes on anything over the $250,000 exclusion amount (if you own the home individually). However, if you don’t sell your home, and instead, you die in 2014, the basis in your home at death is $1,200,000 (the fair market value as of the date of death). Assuming your children sold your home the following day for $1,200,000, they would realize no capital gains and avoid paying capital gains tax.
Double Step Up in Basis
In the example above, we assumed that you owned the home individually. However, let’s assume that you are married, and you and your spouse each own a 50% interest in the home, as your sole and separate property (as is the case in joint tenancy). The law provides that upon your death, the basis in your home increases to its fair market value on your 50% interest in the home. In this case, at your death, 50% of the home is worth $600,000, so you get a step up in basis from $250,000 (what you originally paid) to $600,000, the value of your interest in the home at death.
Your spouse’s basis in the home remains at what he or she paid, $250,000. So, after your death, the basis in the home is $850,000 ($600,000 + $250,000 = $850,000). This is considered a single step up in basis since only your portion got a step up in basis, while your spouse’s basis remained the same. Now, if your spouse sells the home for $1,200,000, with a basis of $850,000, there are gains of $350,000 and capital gains taxes of at least $52,500.
Depending on how your home (or other asset) is titled, you may be able to receive a double step up in basis upon your death. In other words, upon your death, both your half of the home, and your spouse’s half of the home will get a step up so that the basis in the home at your death is now $1,200,000. This is called a double step up in basis.
In order to get a double step up in basis, your home must be titled as community property. For most married couples, they consider their home to be community property, however most of the time, there home is titled in joint tenancy. Contact an Orange County Estate Planning Attorney at Modern Wealth Law to learn how you should take title to your home.
John Wong advises on all aspects of estate planning, probate, asset protection and trust administration. He believes that estate planning is about planning for life; while having protections in place should the unexpected occur.
