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Q&A: "Do I Have to Pay Extra Taxes if I Sell My Home in Less than 2 Years?"

Tax

Question and background: 

Do I have to pay extra taxes if I sell my home in less than 2 years? I bought a home in Phoenix, Arizona, less than two years ago. Now it's too far away from my work, and I want to sell it and move. I heard that I would have to pay extra taxes if I sell before two years is up - is that true? I bought my home for 150,000, and it should be worth that or a tiny bit more (our zip code did really well the past year). Does the tax implication change if I have to move out of state? Thanks!

Answer: 

With respect to federal taxes, there are four issues to think about: (1) capital gain on sale, (2) how long you've owned the property, (3) the federal principal residence capital gains exclusion, and (4) your federal income tax rate. Here's how that plays out....

Capital gain on sale 

Federal capital gains taxes only apply to actual gains on the sale. So first you calculate your cost basis. In your case, that's $150,000, assuming you haven't also made eligible improvements to the home (which would increase the cost basis). So if you sell your home for, say, $170,000, then you'd have a $20,000 capital gain.

How long you've owned the property 

If you've owned the home for less than 12 months, the $20,000 gain above will be a short-term capital gain. If you've owned the home for more than 12 months, the gain is considered long-term. That matters because, if you have capital gains taxes to pay, a short-term gain will be taxed at ordinary income rates, while a long-term gain has preferential rates depending on your income tax bracket.

Federal principal residence capital gains exclusion 

If you sell your home and haven't lived in it for 2 of the 5 years prior to sale, you won't be eligible for this exclusion. But if you have lived in it for 2 of the 5 years prior to sale, a single filer has a $250,000 exclusion from capital gains on sale and a married taxpayer filing jointly has a $500,000 exclusion. 

If you're near the threshold--for example, you've lived in your home for 22 months--that may be reason to delay the sale and move until you have a full 2 years under your belt.

Your federal income tax rate 

If you do have a taxable capital gain and no exemption to offset it, 2014 federal capital gains tax rates are as follows:

  • 0% capital gains tax for folks in the 10% and 15% federal income tax brackets
  • 15% capital gains tax for those in the 25%, 28%, 33%, and 35% brackets
  • 20% capital gains tax for those in the highest 39.6% federal tax bracket

You'll also want to be aware of any state taxes that may apply. Hope that helps. All the best.