What Is Taxable After I Sold the House and Paid Off the Mortgage?

by Beverly Bird
Your mortgage isn't part of the capital gains equation.

The Internal Revenue Service doesn't let you deduct mortgages or liens when figuring capital gains gains – the tax on property sales – even though you must pay them off in order to sell with clear title. A mortgage is both contracted for and paid off during the buy-and-sell process, so it's a wash. This doesn't mean you'll get hit with a huge tax bill when you sell, however. In fact, you probably won't, thanks to IRS exclusions that apply to homeowners.

Tax Basis

The IRS doesn't care how you paid for your home when you purchased it. Your property's basis for capital gains tax begins with the purchase price regardless of how you financed the transaction. For example, if you paid $300,000 for the home, your tax basis is $300,000, even if you took out a mortgage for $270,000. You can add to the $300,000 figure, however, if you made any home improvements. If you added a sun room and it cost you $60,000, your tax basis becomes $360,000. The higher your basis, the less capital gains you'll typically realize.

Calculating Your Gain

After you determine your basis, you can deduct it from the sales price when you sold your house to determine your capital gain. For example, if you sell your home for $400,000 and its basis is $360,000, you have a $40,000 capital gain. You can whittle away from this a little more, however, by deducting costs incident to the buy-and-sell process. For example, you can subtract mortgage points or prepaid interest you paid at closing when you purchased the property, and you can deduct expenses such as your broker's commission and legal fees that you paid as part of the sale. You can also deduct anything you spent to spruce the place up to sell it, provided you made the repairs and cosmetic improvements within three months of the sale date. If these additional costs add up to $16,000, your capital gain becomes only $24,000.

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The IRS allows you to exclude capital gains of up to $250,000, and $500,000 if you're married filing jointly, from tax. You can only use this exclusion once every two years, however, and you must qualify. You must live in your home for two out of the five years preceding the sale, and the house must have been your primary residence. If you don't qualify, the IRS taxes your gain at the rate of 15 percent as of 2013. This increases to 20 percent if your adjusted gross income is $400,000 or more, or $450,000 if you're married and file a joint return.

Special Circumstances

If unforeseen circumstances prevent you from qualifying for the full exclusion, you might still qualify for a partial exclusion – a percentage equal to the amount of time you did reside in your home. For example, if you only lived there for a year instead of the two typically required, you could exclude $125,000 if you're single, or half the exclusion amount. This rules applies if a job change forces you to relocate, or if you become seriously ill so you can no longer afford the mortgage payments and must sell. The two-year residency rule is waived for members of the military who must relocate due to service requirements. If you sell because your spouse has died, you can still take the $500,000 exclusion reserved for married couples if you do so within two years.

About the Author

Beverly Bird has been writing professionally since 1983. She is the author of several novels including the bestselling "Comes the Rain" and "With Every Breath." Bird also has extensive experience as a paralegal, primarily in the areas of divorce and family law, bankruptcy and estate law. She covers many legal topics in her articles.

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