Homeownership & Taxes: How Good Records Can Save You a Bundle

The payoff could be huge and the hassle will be minimal if you keep things in order by maintaining good records relating to your primary residence. At the time you do eventually sell your home, life will certainly be a lot easier and you'll have kept your tax burden to a minimum if you've been keeping good records along the way. A key advantage to having good records is that you can easily calculate the cost basis from which you'll determine if and how much you have to pay Uncle Sam (AKA the IRS) in capital gains tax. In your "home file" you'll want to preserve the records and receipts of any and all improvements you've made to the property. You should include in your file a copy of the Final Settlement Statement (or HUD-1) for the original purchase transaction as this will reflect all the costs associated with acquiring the property; i.e. commissions paid along with title and escrow fees and then you'll want to be sure to hold onto the Final Settlement Statement when you sell the property as it will similarly reflect all of the costs associated with the sale. If your file contains all of these documents, then and only then, will you be able to accurately determine the cost basis of your home as well as the potential tax consequences of the sale. It is the total sum of all of the aforementioned items, subtracting for any allowable depreciation you may have taken on the home, which will ultimately determine your final cost basis.

Once you have arrived at your cost basis figure, now here's the good news. You may not need to worry about paying taxes on the gain because Uncle Sam allows for a capital gains exclusion on the sale of a primary residence in the amount of $500,000 if you are married (and filing a joint return) or $250,000 if you are unmarried. In order to qualify for this welcome tax exclusion you must meet the following criteria:

1. The home was your primary residence for 2 of the past 5 years. Note that
    the 2 year requirement does not have a consecutive year requirement,
    it must simply be 24 months within the prior 5 year period.

2. You have legally owned the home for a minimum of 2 years.

3. You have not used the allowable capital gains exclusion on another
    property you have sold within the previous 2 years.

However if you do not meet this criteria you may still take advantage of the capital gains exclusion if you are selling your home prior to the required 2 year period, if the cause of your sale is due to a medical problem (it is suggested that you obtain a letter from your physician to document this for your own tax records), or if you are forced to relocate due to a job change or transfer. To calculate a partial exclusion simply add the number of months that you lived in the home and then divide that number by 24. Next multiply that number by the applicable exclusion, $500,000 if you are married filing jointly and $250,000 if you are unmarried.

If the profit on the sale exceeds your allowable exclusion, you may then use your cost basis calculation as a means of reducing your tax obligation. Note that a loss occurring from a sale is generally not deductible.

IRS Publication 523 covers the topic of Selling Your Home: http://www.irs.gov/publications/p523/index.html Consult with your tax advisor to discuss your individual tax situation.