- Hi guys, this is Toby Mathis, from Anderson Business
Advisors, and today we're gonna talk about nothing
but selling your house, and when I say your house,
I mean something that you've lived in, in the last two years
as a personal residence or, excuse me, last five years
that you had two of the five years as your
personal residence.
So what we're really looking at, is something that you have
lived in as your primary, personal residence;
not a vacation house, or anything like that.
Something that you actually lived in as your primary
residence, and, we'll go ahead and go over the tests
because there are some exceptions, but we're just gonna
start from the basis that you need to have lived in it
24 of the previous 60 months before you sold it.
And then we'll go over what all the exceptions are,
et cetera, for that.
So first thing to know: all assets that you own, whether
it's a car, your house, anything like that, is considered
a capital asset, and when you sell it, if it's gone
up in value, or if you wrote it off completely
and it's gone up in value, you're gonna have some
amount of taxable gain.
So if you bought your house, and we'll talk about
how to do the calculations, but if you bought a house,
and it's gone up in value, you're gonna have some
sort of capital gain.
If you lose value, if you used it for personal use,
you don't get to write it off.
That's whey if you buy a house and it tanks, you sell it,
you don't get any benefit.
If you buy a rental property and it tanks,
you get to take the benefit.
If you buy a house, convert it to a rental property,
then it tanks, you get to write it off.
If you buy a house, live in it as your private residence,
and it tanks, and then you convert it to a rental,
then you sell it, not the same thing.
There's all little variations, but I hope you guys
get the gist: capital gains is what we're talking about
when you sell an asset.
For homes, there's an exclusion to the capital gains.
It's found in internal revenue code 121.
That's why they call it a 121 exclusion, and this is the
part of the code that says, if you've lived,
and you meet a certain test, if you own the home,
and you lived in it as your primary, personal residence
for two of the preceding five years, you have a
capital gains exclusion of, as a individual,
up to $250,000, as a married couple filing jointly,
up to $500,000.
So in English, I buy a house for $100,000,
my spouse, and own it for 10 years, lived in it
always as my personal residence, and I sell it for
$600,000, I'm gonna pay zero capital gains,
because, when you look at the lookback period,
this five year period, did you live in it two of the
last five?
Yes.
Was it your primary residence during that period?
Yes.
Great, then we have this excludement.
Do we have any periods of non-qualified use?
In other words, did you rent it out any period of time?
No. Then we don't have to worry about it.
Great.
100% exclusion.
That $500,000 of gain is excluded.
You don't have to report the gain.
You pay zero capital gains tax.
That's why it's so powerful.
So first off, I'm gonna contrast this,
this 121 exclusion, which is for the house that you
lived in--
Keep in mind, primary residence, two of the last
five years.
It's not the last two years.
It's two of the last five.
So in theory, I could have lived in it for a number
of years, and then rented it for five years,
and I would still get my 121 exclusion.
It's capital gains exclusion.
If I rented it for three years, there's a good chance
that I would have depreciation.
That is not part of the equation.
I do not get to avoid depreciation.
For you guys that had home offices, that where you did
the home office deduction as a sole proprietor,
that's also considered depreciation.
You also get to recapture that.
So there's some little points in here that,
and that can make it complicated, which is why it's
so important that you listen to these types of
videos, 'cause there's lots of little pieces to it.
And you're gonna see that the exceptions and the variations
can get maddening at times, but what we're lookin' at
is in, in the last five years that I owned it,
did I meet the use test?
In fact, I actually used a step-by-step,
so I say, step number one will be like, hey,
what do I get, like, what will automatically
disqualify me?
Like what things would make it to where I do not
get to use 121?
Number one, if you're an expat.
You don't get to, in fact, what do they say,
you are subject to the expatriation tax.
You're done.
You don't get to take the 121 exclusion.
How about, I 1031 exchanged a property, and now
I've lived in it, but I have not lived in it
for at least five years?
Or let's see, that you acquired the property in
exchange in the last five years.
You're done.
You do not get to take this.
If it's longer than that, you can actually still qualify.
And then if you don't meet the use
and ownership test, then you do not get to take the
121 exclusion.
Now, to that last test, the use and ownership,
there are some exclusions for partial use,
where there are some periods of time where we
can actually defer, which is when you are active military,
peace corps, things like that, and you get deployed.
And we'll go over that.
But, the first thing is to look at this and say,
first off, do I fall into one of these exclusions?
If I do not follow into one of the exclusions,
then I can start looking and I'm gonna be able
to work underneath the statute, the 121,
and I might be able to exclude.
Then we look at the limitations.
It's not 100% of the gain, it's not a percentage,
it's a dollar amount, and so if you're single,
the dollar amount of capital gains you can exclude
is $250,000.
If you are married filing jointly, the exclusion is
$500,000, but, both spouses must meet the use
and ownership test.
This is where it gets funky.
What if you get a divorce, and you give the house
under a decree, to your spouse?
Guess what?
You no longer meet the use test, if you're the one
who got rid of it.
The person who is selling could actually use your use
and ownership as part of their time.
I mean your use, 'cause they're the owner now.
So let's say that I get divorced from my spouse,
spouse takes the property, spouse sells the property.
They can use, the group of us, even just mine,
if I'm the divorced spouse, they can use my use,
but since the ownership is just in the spouse that
cut the property, if it's in their name underneath
the decree, and they transfer that property into their name,
they're the only one who can have ownership.
So you, as the person who divorced, it's not your exclusion.
It's their exclusion, but they can use both.
They can use both to qualify.
Now if it's just them, what do we have?
We have a $250,000 exclusion.
If you guys are trying to do it for yourselves,
then when you divorce, you better make sure
you're both listed on that property,
and they're gonna calculate up, you still have to
meet the use and ownership test.
You're both owners.
Now you both have to meet that use test.
So you're gonna add you both up, which can be a very--
That could be a boon, or it could be a horrific
mistake if the lawyer doesn't catch it,
and you guys transfer title to somebody.
There's a few others, which we'll go over.
But we look at it and we say, are you the owner?
And what they look at is if you owned the home
for at least 24 months, two years, out of the last
five years, leading up to the date of sale,
you meet the ownership requirement.
For a married couple, if you're still married,
only one spouse has to meet the test for ownership.
You still both have to meet per use.
And that's the next step is where we look at it
and say, what is it used?
It has to be your primary residence.
So here's where it gets fun.
If you did, then, and the 24 months can fall
anywhere in that five years, then it has to be
your primary, personal residence.
So some people have two personal residence.
It has to be the primary, and they actually
do some tests, and so they're always gonna look and say:
where did you actually stay?
Now there are some exceptions, if you can't take care
of yourself and things like that, but we're not gonna
get that into that.
That's for somebody who has to, who needs assistance
and actually has to be removed from the home for
reasons, which we'll get into, but, let's just say
for general purposes, you must own it and have used it
as a personal residence.
You have to own it at the time that you're selling it.
You have to have used it as a personal residence
in 24 of the, or two years of the previous five.
And we look back, and we say are there any exceptions
to that eligibility, and that's where we have
some exceptions, and so let's take a look.
A separation or divorce during the ownership of a home,
and then we take a look, like, that's gonna be exception
for the use, not the ownership.
So again, if you no longer own the house, and it sells,
it's not your exclusion, it's the spouse that owns it.
If you both still own it, you're both still on title,
then we can add it up and you guys can actually
both get your exclusion.
Death of the spouse, and then you have a period,
you have a two-year window of where you would sell it
and they would treat it as though you would be able to
take advantage of both spouses as owners.
Vacant land would be carved out potentially,
if it was used as part of your residence.
So like, if you had a big yard, and you sold part
of the yard, then it may be part of your exclusion.
You might be able to get a portion of it.
And finally there's some other exceptions, but
we won't get into those right now.
I just wanted to touch on each one of those.
If you are spouses, and you don't make up and you
don't meet the 24 month test, and you're looking back
at the use, what they would do is they would say,
we're gonna treat you each as single individuals,
so the spouse that lived in it previously that
still owns it, and you're selling it, so you know,
example, I lived in a house, I get married,
we sell it a year after we get married, and they would say:
oh, you're not completely toast, you're not completely
excluded, you would just treat you each as single people
and so my use and ownership, I might meet it, so I might
get a $250,000 exclusion, even though we're married,
filing jointly.
I don't get the full 500, but at least I get the 200,
or the 250.
And let's say that it's jumped up in value, and I meet
one of the exclusions to that eligibility test.
The exclusion, like we had to move for work,
or for health or go over what those are.
Then even my spouse, even though, let's just say
she did not live in it for two of the last five years,
she would fall under one of the exceptions for a
partial exclusion, then you would get hers as well.
So, there's always little nuances.
Like I said, this stuff can get maddening.
If anybody ever says, "Oh, it's just straightforward
"and easy.", it is not.
I assure you.
So then we look at the limits.
And so we look and say, do you meet the use
and ownership test?
And then let's take a look and see, are there any periods
of disqualified use?
And here's what I'm talkin' about.
Disqualified use kinda goes like this: I'm a landlord.
I own my rental property, and then some smart lawyer
says, hey make it your house.
And if you sell it, you have this big exclusion.
Okay, I have a period of disqualified use.
So let's say that I had it a rental for 10 years,
and then I lived in it for two, and I sold it.
I would have a large portion of the gain disqualified.
The 10 compared to the two.
That's the proportionality and they would say,
hey you're gonna get a two 12th portion of the
exclusion, because you lived in it, when we add up
all the days, and they actually go by days, not by months.
You go by days, and you say, what portion of it was
the residence, and what portion of it was used for business?
So, there's a big portion that could be disqualified,
and we call that disqualified use, that's gonna give you
a partial exclusion.
The other portion is, like, things that will automatically
exclude you, is you're only allowed to take the
121 exclusion once every two years.
So, I can't have a house that I lived in for two years
as my primary residence, buy another one, live in that
two years, and then sell them both in the same year
and expect my exclusion.
I get to take one exclusion every two years.
What I would have to do is sell one of the houses,
make sure that I'm still qualifying for the other one,
and then wait two years and sell another.
There's people that do that, and they use the exclusion
every two years.
If you try to sell one within two years,
it's just an automatic denial.
That's just an automatic exclusion.
The other exclusion, as we talked about, was if you
1031 exchange within five years.
Just done.
You 1031 one of your rental properties and then you
moved in it for two years, and then you sell it,
you 1031'd within five years, done.
You don't get to use the 121 exclusion.
You're just done.
And then the other way is just to fail the use
and ownership test, in which case, there, we have some
exceptions, what we call partial exclusions that
we could use.
So just kinda step number one, going all the way back
to the beginning, is you determine whether there's things
that automatically keep you from qualifying,
assuming that you're not an expat, that you didn't just
1031 exchange it, that um, you haven't done an exchange
within the last 24 months, then we're gonna take to
step number two which is to look at the use and ownership
test, and we're gonna go through that.
We're gonna determine whether there's a period of
disqualified use, and we're gonna calculate
all this fun stuff.
Remember, this is only for capital gains.
So, there might be some depreciation that gets to be
recaptured, and when you do the worksheet,
when you actually look at what the IRS requests
when you actually do the calculations, you're gonna see
that that gets excluded from gain.
And I'll go over how you actually do the calculation
here in a second.
And that portion's gonna be subject to divided recapture.
So again, going back to the example of: I owned it as
a rental for 10 years, then I lived in it for two,
then I sold it, there's 10 years of depreciation.
That's not part of the gain.
That actually comes off the top, and that's subject to
depreciation recapture, which would be at 25% right now.
That would be subject to that taxation.
I can exclude a portion of the gain.
Like, I don't just lose it.
I would get two 12ths under that example of the
gain excluded.
So there's always these kind of exceptions.
The other area of exception is if I was forced to move.
So let's say that I owned it, and I sold it,
but I didn't meet the use test.
Then there are a few exceptions and this is when we look
and say do I get a partial exclusion?
And here's the partial exclusions.
So, this scenario is, I lived in the house.
I lived in it for a year as my primary residence,
and then I had to sell the house because I was forced
to move for work.
And if you worked, then it's gonna be at least
50 miles farther than the old location.
50 miles farther from your home.
So it's not just 50 miles away.
It's 50 miles farther away than your old location,
and so, let's say that you had a house, and you
commuted 15 miles to work.
The new house needs to be at least 65 miles away.
Hope that makes sense.
And then I can get a partial exclusion.
So if I'd be entitled to a $250,000 exclusion if I had
lived in it for 24 months, but I only lived in it for 12,
then I would get a $125,000 exclusion.
I would get half of the exclusion, 'cause I lived in it
half of the time.
That's the partial exclusion.
A health related move will work also, and that's if
you had to do it to facilitate a diagnosis,
to cure some health issue, or if you had to care for
family members, and the family members can be a child,
grandparents.
They actually have a list: brother, sister, mother-in-law,
aunt, uncle, nephew, niece, all these things could be
included.
And then they have some catch-alls.
They say unforeseeable events, and so unforeseeable events
can be the death of a spouse, could be a divorce
or separation, those things would might allow you.
So if you buy a house and then your spouse pops on you
that they wanna get divorced, and you sell it a year
after you guys move in it, you didn't meet the 24 months,
but you have ownership.
You guys both on ownership, but then the use wasn't,
you'd get a partial exclusion, if that was the cause
for the move.
If you have twins, triplets, quadruplets, quintuplets,
you know, you just keep going.
If you had more than one child unexpectedly,
then that's gonna give you grounds, also, for a
partial exclusion.
And then if you lost a job or something like that,
that could also give you a partial exclusion.
Other facts and circumstances, they would look at,
basically this is where you throw the kitchen sink
at 'em, saying hey we didn't anticipate something occurring,
and this is the reason we had to move, and you can
try your best on that one to get a partial exclusion.
I've never seen too many of those come along, but
they do happen.
Now here's another little thing: there's a few points
of clarity if you've been using your house at all
as a personal residence after you've been renting it,
or if you rented it after you used it as a personal,
after the personal use, because they're treated
very differently.
So first off, we'll go to the first thing we were talking
about which is the disqualified use.
If you'd used it as a rental and you had a rental property
then you moved into it, the period of the rental
is disqualified use, as we talked about.
However, if you use it as your personal residence,
your primary, personal residence for two years,
and then rent it after that, and then sell it,
as long as that sale is within three years, so that you
still meet the two out of five, that portion doesn't count.
We don't count that.
Put another way, if I've lived in a house for 20 years,
and then I decide I'm going to rent it out, and I
rent it out for less than three years, the way the rule
is written is they don't count that as disqualified use
so long as the date that you sell two of those last
five years, you used it as your primary residence.
They don't count that portion as disqualified use.
So, in one case, somebody has it as a rental,
they move into it, and they use it for their personal
residence for two years, then they sell.
There'd be a period of disqualified use that would mean
that they'd lose a substantial portion of the exclusion.
So, let's just use round numbers.
I rented it for two years, lived in it for two years,
sold it, so I owned it for four years total, I would get
half of the exclusion that I'm entitled to.
So a married couple, married filing jointly,
they'd have a $250,000 exclusion.
A single person would have a $125,000 exclusion.
You just cut the numbers in half.
There's another portion of that, of course,
which is the depreciation,
if they depreciated that property.
That's not part of the gain, that's not part of the
exclusion, that's depreciation recaptured.
It's actually 25%, so you'd end up having to
do that calculation.
If, let's flip it around, I lived in it for two years,
then rented it for two years and sold it,
and I only owned it for four years, I get 100%
of the exclusion, 'cause we don't count those years
after I lived in it as my primary residence,
so the one, the reason that rule is there,
is to prevent landlords from just going in and
moving in to their houses for two years and selling,
and every two years just selling one of their properties
that may have substantial appreciation.
They just wanna--
They don't want anybody to be gaming the system
in that way.
Now, where it's fully allowed, and the IRS actually
has the calculation written out on its website,
it is when you have appreciation, that's far in excess
of what you're allowed to take.
So for example, in the, let's say you're in San Jose,
or San Francisco area, where you've had this big,
huge run up and you buy a house for $500,000,
10 years ago and now it's worth 2.5 million.
So if you were to sell it, you'd have two million dollars
of gain, and you might be able to exclude $500,000
of it if you're married, filing jointly,
if you're following me.
So, you meet the use and ownership test, you get the
full exclusion, but it's not enough.
It's a half a million dollars that's just gonna
put a, just a little dent.
So you paid half a million, you got two million dollars
in gain, so you're gonna get--
You're gonna get exclude $500,000 of that.
You're still gonna pay a big chunk of tax.
If you want to avoid all the gain, here's how you do it,
and they spell it out.
You would take the house that you lived in
as your personal residence, and you'd convert it
into a rental, and I would suggest that you rent it
for at least a year.
There's not a hard and fast rule on that.
You just have to make it into a rental property,
an investment property.
Once it's an investment property, it can qualify
under 1031 exchange.
So, you're allowed to go out and buy other investment
properties with it.
Now it doesn't mean you can go out and buy another house
you're gonna live in, but you could buy
investment properties and after a while make those
into your personal residence.
Again, you work with a tax advisor on this,
but you could exclude the 1.5 million dollars in gain.
So, I could actually take a house, I've lived in it
for five, you know say, lived in it for five years,
it's a highly appreciated, half a million dollars of gain,
we're gonna get to write off half of it, and I want to
avoid the gain on the other half.
I could convert that into a rental property, rent it to
somebody, and what am I gonna do in the meantime?
You could either go rent a house, you can go and
buy another house, because you're allowed to use
the 121 exclusion every two years, but you don't have to
live in it the day that you sell it.
It doesn't have to be your primary, personal residence
the day you sell it.
You just have to have met the use and ownership
requirements of two out of five years prior to sale.
So then you would sell that, say a year later,
and you would be able to 1031 exchange it into
other properties.
And then those other properties, after you buy them,
technically, you could actually go and move into those
at some point and make 'em into your primary residence.
You'd probably say let's just keep 'em as rental properties.
Let's go buy a bunch of rental properties and go
buy another house that you could live in, or rent another
house if you wanted to live in it or just, you know,
if you're in this situation, chances are you have the means
to go out and buy another home, and you wouldn't have to
worry about it.
But, you can avoid the gain entirely if you want to.
So it is a possibility.
Last thing is how you actually calculate gain.
And so as you've heard me say, depreciation is not
included in the capital gains exclusion.
So the way the IRS has you do the test, is they say
what is your basis?
You've gotta calculate up your basis,
and I'll go over that in a second.
You take the gain, and you subtract the basis off the gain
and that gives you a number.
I mean the total sale minus the basis is gonna give you
your gain, kinda the first level of gain.
They say write down this number, then you exclude from
that gain any depreciation recapture that comes from
having done your house as a home office, or having
taken deprecation if it was an investment property.
So, if you have any of those numbers, let's say you had
$500,000 of gain, but you had $25,000 of depreciation
recapture, you no longer have $500,000 of gain for
purposes of this section, you have $475,000 of gain,
and then you'd actually take that $25,000 of depreciation
recapture and recognize it on your schedule D.
So, there's a portion of it that would be excluded
from tax, and then you'd have a 25% tax on that
depreciation recapture.
The way you calculate all these things, and the
most important numbers are: what are you selling it for?
It doesn't have to just be cash.
It could be other properties that you get in exchange
or other services that you, you figure out what's the
actual sale price?
99.9% of the time, it's just gonna be cash.
It's gonna be, you know, I'm selling it for US currency
and it's easy to calculate.
Make life, your world more difficult is to try to
add bitcoin.
I don't even know any escrow companies that really
wanna deal with that right now, but whatever you do,
whatever you exchange, whatever the value is,
is what your sale price is, and then from that
you remove the basis, and basis is what you purchased the
property for, plus we get to add things into it,
and like, that add into it is your fees and closing costs.
For example, abstract fees, utility services that
you had to pay, recording fees, survey fees, transfer.
You may have paid these when you bought the property,
but they get added in to your basis.
You never got to write them off.
Construction, you would add in the cost of labor materials
on any construction that you did, even if you had to pay
real estate taxes up through the date of the sale date,
if you were paying it for something that you paid
to the seller, for example: hey, I'm gonna pay off
some of the taxes, you didn't get to write that off,
'cause you didn't own it.
So you would just add it into your basis.
Bank, or back interest, even recording fees,
if you agreed to pay some of the closing costs,
and even if you paid some of the sales commissions,
like, hey I really want this house and they shifted
them over to you.
That gets added into your basis.
Don't forget to calculate that.
Big things that are example of improvements that we see
some people miss, and I'm gonna go through a whole bunch,
just to make sure that you're filling your head in
with what things get added into basis, 'cause this comes
right off the gain.
This is something you immediately write off, so it's like,
makes life easy if we have zero net gain, and we don't
have to worry about anything, right?
Additions are anything that you added as a bedroom,
bathroom, deck, garage, a porch, a patio.
Any of that stuff gets added into your basis.
Your lawns and grounds, your landscaping, if you added
a driveway, walkways, fences, retaining walls,
swimming pool, any of that gets added into your basis.
Systems like your heating systems, air conditioning,
furnace, duct work, central humidifier, air filtration,
water filtration, wiring, security system, even if you
put in a sprinkler system for your lawns,
all that stuff goes in.
Plumbing is your septic system, your water heater,
soft water, if you live in, like I do in Las Vegas,
everybody has a soft water system.
All that gets added into your basis.
Interior, if you have built in appliances, those got
added into your basis.
Kitchen modernization, if you upgrade your, you know,
the doors on all your cabinets, that type of thing,
flooring, wall-to-wall carpeting, all that stuff
comes in.
Fireplaces, even if you put in insulation into your attic
or into your garage.
Some people are doing that now underneath the floors,
pipes, all that stuff, if you're in, all that gets added.
Big things that you might do outside, satellite dish,
and your siding, even putting on a new roof.
All that gets added in to your basis.
And so when you're calculating out what gain you have,
you gotta know what's the sale price minus what's the
sale price minus what the basis is, and that's gonna
give you your primary number.
If you did not, if you never rented out your house,
or if you never used a home office, or even if you did,
you did not take the deduction.
In other words, you didn't do it on your schedule C
during the period of time when we had the dividend,
they consider that a dividend, which isn't anymore,
but if you did in the past five years or so, you may have
some dividend recapture, and this does not include
reimbursements that you took.
Like if an employer reimbursed you for the use
of your house, that doesn't get reported anywhere.
That's not depreciation recapture.
But if you did not have any of that, or if you did
rent your house out, but you did,
you took zero depreciation then you don't have to
worry about it.
You just use the capital gains exclusion
that you have under 121.
I hope that this helps, and I hope that you realize
that anybody who says, "Oh 121 exclusion, this is
"what it is.", it's not.
There are lots of little exceptions.
We didn't even, like there's some crazy ones that are
out there, I don't wanna bend your head on,
but if you're a member of the service and things like that,
we can actually have periods of deferment that are
up to 15 years that we can stretch the test on.
Even if you're deployed for 10 years, we can still
go back and capture this.
So, the point of this is just to know that
121 is a boon if you're selling a house you don't
wanna pay capital gains.
If you have too much appreciation, you can actually
couple this with your 1031 exchange, or actually do
the 121 exclusion plus the 1031 exchange.
Way it works is the 121 exclusion gets added into basis,
so if you have the 2.5 million dollar house that you
bought for $500,000, the new basis and the new properties
is a million.
You get to use the 121 exclusion and the $500,000,
hit a million.
You get to, if you're rolling it into other
investment properties, you exclude
the 1.5 million dollars gain.
It's amazing, 'mazing tool, but there's a lot of different
nuances to this that makes it something that you
really should have somebody run the numbers with,
for you, doing it.
But I hope that helps.
Toby Mathis with Anderson Business Advisors.