Buying a new house before selling your current home can leave you owning two properties for a time. For US taxpayers, that overlap does not by itself create a separate federal income tax. The important questions concern the gain on the eventual sale, the deductions available while both homes are held, and any rental use of the former home.
This guide covers federal tax principles for personal residences. State and local rules may add transfer taxes, recording charges or different treatment of capital gains. Check the rules that apply where each property is located before committing to a transaction.
Buying First Does Not Cancel the Home-Sale Exclusion
The purchase date of the new home is not part of the basic test for excluding gain on the old one. You may still qualify after moving out, provided the former home meets the ownership, residence and look-back requirements described in the IRS home-sale tax rules.
For the full exclusion, a seller generally must have owned the home and used it as a main residence for at least two years during the five years ending on the sale date. Those periods need not be continuous. A seller also generally must not have claimed the exclusion on another home sale during the previous two years.
The maximum exclusion is normally a fixed statutory amount of gain for an eligible individual, and double that for eligible married couples filing jointly. Check the published figures with the IRS before relying on them. The higher amount has additional joint-return conditions. These limits apply to gain, not to the sale price. The IRS home sale capital gains exclusion rules explain when a sale must be reported.
Moving into the new home starts no special countdown that automatically disqualifies the old one. Time does matter, however. A long delay may move earlier months of residence outside the five-year testing period. If you have not met the full tests, a reduced exclusion may sometimes apply after a qualifying change in employment, health issue or unforeseen circumstance.
Calculate Gain Before Judging the Tax Cost
Start with the amount received for the old home, subtract allowable selling expenses, and then subtract its adjusted basis. The result is the gain before any available exclusion.
Sale proceeds minus selling expenses minus adjusted basis equals gain.
Adjusted basis usually begins with the purchase cost and certain settlement costs. Add qualifying capital improvements, such as an extension, replacement roof or substantial remodelling. Do not automatically add routine maintenance and repairs. Subtract items that reduce basis, including depreciation allowed or allowable for rental or business use.
Selling expenses may include an agent's commission, legal fees and other costs directly connected with the sale. Review the final settlement statement rather than estimating them. A loss on the sale of a personal main home is generally not deductible, even though a gain may be taxable.
Buying the replacement property does not roll gain into the new home's basis or postpone tax on the old home. If gain remains after the exclusion, it may be subject to federal capital gains tax and possibly state tax. The sale date also determines the tax year in which the transaction is considered, so a closing near year-end can affect filing and estimated-payment planning.
Deductions During a Period of Overlap
Owning two homes can increase interest and property-tax payments, but paying an expense does not guarantee a deduction. Personal deductions help only if you itemise and the total exceeds the standard deduction available for that return.
Mortgage interest
Interest may qualify for a main home and one second home when the properties and loans satisfy the qualified-residence and acquisition-debt rules. Limits apply to the combined qualifying debt, not separately to each mortgage. The loan's date, purpose and security all matter, so compare both closing files with Publication 936 on home mortgage interest.
Do not assume that interest on temporary or home-equity borrowing is deductible merely because a house secures the loan. How the money was used and which property secures the debt can change the result. Keep the loan agreement, closing disclosure and a clear trail showing where the borrowed funds went.
Property taxes and personal costs
Eligible real property taxes paid on both homes may form part of an itemised deduction, subject to the federal limit on state and local tax deductions. An escrow payment is not necessarily deductible when paid to the lender; the relevant amount is generally what the lender pays to the taxing authority during the year.
Use each closing statement to allocate property taxes between buyer and seller. Separate taxes from charges for services, association dues and special assessments, which may receive different treatment. Utilities, homeowners' insurance and ordinary upkeep on a personal residence are generally personal costs rather than federal income-tax deductions.
Financing Choices Affect Records and Cash Flow
Buying before selling may require cash reserves, two mortgages or short-term borrowing against home equity. These are primarily financing decisions, but their structure can affect interest deductions and the documents needed at tax time.
Model the overlap using a sale date later than the one you expect. Include both mortgage payments, taxes, insurance, utilities, maintenance and the costs of any temporary loan. Also ask what happens if an expected sale falls through, the lender changes the available credit, or repayment is due before the old home closes.
Ask each lender to identify which property secures each debt and how loan proceeds will be documented. Preserve wire confirmations and settlement records. Paying off temporary borrowing with sale proceeds is a cash-flow event; it does not by itself turn the interest into a deductible expense.
If the Former Home Becomes a Rental
Renting the former home, even briefly, changes the recordkeeping and tax analysis. Rental income must be reported, while eligible rental expenses may be deducted under the applicable rules. The date the property is ready and available for rent is important, as are any days of personal use.
At conversion, record the home's adjusted basis, a supportable fair market value, and the portion attributable to land. The basis used for depreciation is generally limited to the lower of adjusted basis or fair market value at conversion, and land is not depreciated. Publication 527 for residential rental property covers rental income, expenses, depreciation and mixed personal use.
Keep the listing or lease, rent records, security-deposit records, invoices, insurance statements and evidence of the conversion date. Distinguish repairs from improvements: a repair may be a current rental expense, while an improvement is normally added to basis and recovered over time.
A later sale may still qualify for some or all of the main-home exclusion if the ownership and residence tests remain satisfied. Rental use can nevertheless affect the calculation. Depreciation allowed or allowable for rental use generally cannot be sheltered by the home-sale exclusion, and other periods of non-residential use may require separate treatment.
Build a File Before Either Closing
Good records often matter more than the order of the two transactions. Retain documents for as long as they may affect the basis, deductions or sale of either property.
- Purchase records: contracts, deeds, closing disclosures, settlement statements and evidence of qualifying acquisition costs.
- Improvement records: invoices, proof of payment, permits and descriptions showing what work was completed and when.
- Financing records: loan agreements, annual interest statements, payoff statements and evidence tracing borrowed funds.
- Ownership costs: property-tax bills, escrow statements and records separating taxes from service charges or assessments.
- Sale records: the listing agreement, final settlement statement, selling-cost invoices and any tax forms issued for the transaction.
- Rental records: availability dates, leases, income, deposits, expenses, personal-use days, valuation support and depreciation schedules.
Before making an offer, estimate the gain on the old home and test whether the expected sale date preserves the ownership and residence requirements. Before converting it to a rental, establish basis and fair market value. Seek individual tax advice when the home has mixed use, shared or trust ownership, a divorce or inheritance history, prior depreciation, or a gain above the likely exclusion.