The amount of the proceeds from the sale of your home that you use to pay off the mortgage isn't a factor in figuring your taxable amount for the sale. Instead, the amount you realize on the sale of your home and the adjusted basis of your home are important in determining whether you're subject to tax on the sale.
If the amount you realize, which generally includes any cash or other property you receive plus any of your indebtedness the buyer assumes or is otherwise paid off as part of the sale, less your selling expenses, is more than your adjusted basis in your home, you have a capital gain on the sale.
Your adjusted basis is generally your cost in acquiring your home plus the cost of any capital improvements you made, less casualty loss amounts and other decreases. For more information on basis and adjusted basis, refer to Publication , Selling Your Home.
If you financed the purchase of the house by obtaining a mortgage, include the mortgage proceeds in determining your adjusted cost basis in your residence. To take advantage of this exception, the taxpayer must meet the following conditions Sec. Most often, taxpayers do not qualify for capital gain treatment under the five-year rule because they do not meet the substantial improvement requirement.
Substantial improvements include "installation of hard surface roads or utilities such as sewers, water, gas, or electric lines" Regs. Under the year rule, a taxpayer can still receive capital gain treatment even though improvements were made to the land. Under certain circumstances, a taxpayer can elect to have substantial improvements treated as necessary and not substantial if all of the following conditions are met Sec. At first glance, it may not seem beneficial to make the election to treat the improvements as not substantial since the taxpayer cannot include the cost of these improvements in the basis of the asset and cannot deduct the correlating cost as an expense.
However, there may be a significant tax benefit to making this election in some circumstances:. Even if the property is subdivided and the parcels are sold off incrementally, Sec. Under this fact pattern, a couple of additional opportunities are available:.
In a recent Tax Court case, Rogers , T. While the court refused to address the issue because the taxpayer did not properly raise it, the court indicated it did not agree that Sec. As the case suggests, the decision to apply Sec. Overall, Sec. Editor Notes. Most taxpayers do not qualify for capital gain treatment under the five-year rule because they do not meet the substantial improvement requirement, which includes installation of hard surface roads or utilities such as sewers, water, gas, or electric line Regs.
Under the year rule, the taxpayer can receive capital gain treatment even though improvements were made to the property. A taxpayer can elect to have substantial improvements treated as necessary and not substantial if all of the following conditions are met Sec. At first it may seem beneficial to make the election to treat improvements as not substantial, since you cannot include the cost of these improvements in the basis of the asset and cannot deduct the correlating cost as an expense.
A taxpayer may be able to maintain investor status even if the property is subdivided and sold off incrementally. Under the installment sale treatment, the gain can be deferred until the installment payments are received. The gain may also be deferred under the like-kind exchange provisions of Sec.
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