The argument started as we sat down for Easter dinner. My cousin had recently sold his home and my uncle was giving some, incorrect, tax advice on how he now needs to buy a new home to avoid paying taxes. I reminded my uncle that this only applies to rental and vacation properties and not his primary house, so he will have no taxes on the sale. Of course this is when the argument heated up. Soon, the room was filled with tax experts. Voices raised, incorrect tax laws cited, and Easter ham ignored. This post is meant to address the great Easter debate of 2018. Do you pay taxes on the sale of your home in Michigan?
Sale of Primary Residence
I have really good news for us in Michigan, and maybe not such great news for my uncle. You probably will not be taxed on the sale of your primary residence in Michigan. As long as you have lived in your home for at least 2 of the past 5 years, you can exclude up to $250,000 ($500,000 if you are married) on any gain from the sale of a primary residence. In order to exclude that gain there are two tests that you have to meet; the use test and the ownership test.
From the IRS website, you must meet both tests in the past 5-years to exclude the gain from the sale of your primary residence.
- The use test- lived in the home as your main home for at least 2 years
- The ownership test- have owned the home for at least 2 years
So, assuming that you only have one property and you have owned, and lived, in that property for at least 2 of the past 5 years, you can exclude $250,000 (or $500,000 if married) on any gain of the property. For most of us, this means that we will not pay federal or Michigan state taxes on the sale of our main home. If you have gain over the exclusion amount however, you will have to pay taxes at the capital gains tax rate. When you have multiple homes, this gets a little trickier.
When you have multiple homes
If you have a main home and either a vacation or rental home, you need to be careful when you are selling your property. Typically, if you have a gain, you will have to pay capital gains taxes on the sale of a vacation home or rental property. Also, you may have higher taxes if you have depreciated any of the property while you have owned it. I suggest working with a tax planner, if planning to sell a rental or vacation property.
Your main home is the home that you live in most of the time. If you have a house in Troy that you live in and a lake cottage in northern Michigan that you visit on the weekends, your home in Troy would be your main home. It is this main home that you would be able to sell and exclude the gain, as long as you have lived there for at least 2 of the past 5 years. You would pay capital gains on the sale of the vacation home, assuming you have not met the use or ownership test described above.
Tax planning when you have multiple homes
I was recently working with a couple that was transitioning into retirement and wanted to downsize the main home and sell their Higgins Lake cottage, so they could spend more time in Florida. They had owned the cottage for years and had a fairly sizable gain. Therefore, they were going to be hit with a pretty sizeable tax when they sold the cottage. The goal was to take advantage of the exclusion on both properties. An important part of the $250,000 ($500,000 if married) exclusion is that you can only use it once every 2-years, but there are no limits to how often you use it. Therefore, we were able to devise a strategy to use the exclusion on both homes.
First, when the couple retired, they sold their main home in Rochester. They used the proceeds from the main home to purchase a house in Florida. Then, the couple made the Higgins Lake home the primary home, and spent 7 months a year there for 2-years. After the 2-years, they sold the Higgins Lake cottage and were able to exclude the $375,000 worth of gain. This strategy saved over $50,000 in taxes for this family!
Well as you may have guessed, my cousin didn’t have to pay any taxes on the sale of his property. It was his only only house and he lived there for over 2-years. He had a pretty easy situation but those who have more than one home, may need to do some planning to take full advantage of your tax exclusions. So, next time you have this argument with the local tax expert/uncle/coworker, show them this article. Now, back to that Easter ham.