Required Tax Filings
After you sell your house, you don't need to immediately report the sale to the Internal Revenue Service. Rest assured, however, that the IRS knows of the sale because whatever firm handles the closing reports the financial details of the sale on Form 1099-S. You should receive a copy of this form, as well.
Form 2119: "Sale of Your Home"
When the time comes to file your annual IRS Form 1040, you need to complete Form 2119, "Sale of Your Home", if you sold your house. Whether you made or lost money on the sale, you must complete this form and file it with your Form 1040.
Gain on sale
The first part of Form 2119 which you have to fill out no matter which rules you're subject to, is by far the hardest part to complete. You need to tally the expenses involved in selling your house, and you also need to determine the amount the IRS calls the cost basis of the house. Determining the cost basis gives many a house seller a headache because this figure reflects not only the amount you originally paid for the house but also the money spent on improvements while you owned the property.
To calculate your gain on the sale, you need to determine two important numbers: expenses of sale and adjusted cost basis of the house you sold.
Expenses of sale
After you sell your house, the IRS allows you to deduct from the selling price certain expenses incurred in the transaction, such as the following:
- Real estate agent commissions
- Attorney fees
- Title and closing fees
- Recording fees
- Advertising expenses
- Buyer's loan fees
Unfortunately, paying off your outstanding mortgage does not count as an expense of sale.
Adjusted cost basis
For tax purposes, the cost basis of your house starts with the price you originally paid for it, including certain closing costs, which the IRS allows you to add to the purchase price of the house. During the time you own the house, however, that basis can change. Home improvements increase your cost basis by the dollar amount you spend on them.
- In the eyes of the IRS, an improvement is anything that increases your home's value or prolongs its useful life, such as landscaping, installing a new roof, adding rooms, installing a new heating or air conditioning system, and so on. On the other hand, repairs that simply maintain your home's condition -- fixing a leaking pipe, repainting, replacing a broken window, spackling holes in walls and baseboards -- are not considered improvements.
- Another factor that may affect your cost basis is depreciation taken for rental or business use of a portion of your property over the years. For example, if you convert your 2-car garage into an office or if you're renting a spare room, you can take depreciation on the portion of the property devoted to business or rental purposes. Depreciation reduces your property's cost basis. (Note: The portion of your property devoted to business or rental purposes is not eligible for the tax deferral under the primary residence tax deferral rules.)
Here's a simple example to show how the IRS wants you to calculate the gain on your house sale in Part I of Form 2119. Suppose that you bought your house for $100,000. Over the years of ownership, you spent the following on improvements:
- $6,000 on a new roof
- $2,500 on landscaping
- $1,500 on new electrical wiring
Thus, you raise your cost basis in the property to $110,000. You sell the house for $200,000. However, after paying real estate commissions and other expenses of sale, you only receive $180,000. Thus, your profit as defined by the IRS comes to $180,000 - $110,000 = $70,000.
Confirm all information with your accountant or attorney.