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I am under the understanding that the capital gains exemption on a primary residence applies to gains only and not the total sale price of the house however I am in the process of signing paperwork for the sale of my home and one of the pages is concerning.

I am married and my wife and I will be selling our home for around $640k. We should be getting a little over $260k back after expenses and paying off the existing mortgage. My understanding is this should be completely tax free as it's under the $500k capital gains exemption for married couples.

One of the pages in the package I signed asked the following question(s) (true or false):

At least one of the following three statement applies:
The sale or exchange is of the entire residence for $250,000 or less.
OR
I am married, the sale or exchange is the entire residence for $500,000.00 or less, and the gain on the sale or exchange on the entire residence is $250,000.00 or less.
OR
I am married, the sale or exchange is of the entire residence for $500,000 or less, and (a) I intend to file a joint return for the year of the sale or exchange, (b) my spouse also used the residence as his or her principal residence for periods aggregating 2 years or more during the 5-year period ending on the date of the sale or exchange of the residence, and (c) my spouse also has not sold or exchanged another principal residence during the 2-year period ending on the date of the sale or exchange of the residence (not taking into account any sale or exchange before May 7, 1997).

I answered false to this but does this mean I'll be paying capital gains tax? Should I have answered true? Has the law changed? Or am I just reading too much into this because it doesn't actually say anything about taxes?

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2 Answers 2

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No, the law hasn't changed, your understanding is incorrect.

Your gain has nothing to do with the money you get from the sale (which is "proceeds") or your current mortgage balance (which is "debt").

Your gain is gain = sales price - sale expenses - cost basis.

Sales price is the price listed in the contract.

Sale expenses are the closing costs listed in the HUD-1.

Cost basis is the amount you spent to buy the house (the bottom line on your HUD-1 during purchase), additional money you've invested in improvements (i.e.: renovation costs, but not repair costs), minus depreciation that you've taken (if at all, if you rented the property or deducted home office expenses) and minus various related credits (if for example you got first time buyer credit).

The proceeds, on the other hand, is proceeds = sale price - sale expenses - current debt payoff. That is, the money your buyer paid, minus the closing costs and minus the remaining mortgage balance.

You may have gain with no proceeds (short sale), or proceeds with no gains (sale at a loss).

The statement you acknowledged is probably related to withholding. If you're expected to exclude all of your gains you wouldn't want any tax withholding from your sale proceeds.

You'll need to figure out what your gain is expected to be, not the proceeds. For that, knowing your current outstanding mortgage balance and sale price is not necessarily enough (but may be enough if you only took out the mortgage at acquisition time and never did cash-out refinancing, and never rented the property out).

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  • Thanks. Yeah I never did any refinancing or rental. I know for a fact that my gain will not be over $500k and is not even over $250k if I factor in improvements. So is this withholding paperwork a bad thing?
    – jesse_b
    Apr 11, 2022 at 20:20
  • @jesse_b why bad thing? The escrow agent has to verify this in order to allow you to reduce the mandatory withholding before distributing the proceeds.
    – littleadv
    Apr 11, 2022 at 20:21
  • Yes but the paperwork makes it seem like I am not exempt because I had to answer false to it. Even the person that gave me the paperwork seemed to think the exemption only applies to total sale price and not gains.
    – jesse_b
    Apr 11, 2022 at 20:21
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    @jesse_b you may not be exempt. Whether you are exempt or not you'll determine on your tax return, but since you may not be exempt, you are probably unable to avoid withholding (which will be refunded to you after you file your tax return).
    – littleadv
    Apr 11, 2022 at 20:22
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    Right. Basically the IRS says 'you haven't filed yet so we don't know yet if you owe us, so just to be sure we withhold some of it before it's all gone'.
    – Aganju
    Apr 12, 2022 at 6:14
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The purpose of that statement is to determine whether the broker needs to issue a 1099-S showing the sale proceeds. If you answered yes to that question, then no 1099-S would be issued. Since you cannot answer yes, a 1099-S will be issued, you will report the sale on your tax return, report the exclusion, and the resulting capital gain shown on your return will be 0.

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