Reconsider Your Home Sale: 4 Tax-Smart Options When the Market Stalls

Are you ready to move and want to sell your home, but you're worried about a slowing real estate market? You're not alone. Many homeowners want to move up to a bigger home or downsize to a smaller one. However, they're currently unable to sell their homes for the price they want. Fortunately, selling isn't your only option. The current market could be an opportunity to rethink your next step, especially when you take the tax implications into account.

Basic Home Sale Rules

First, let's review the tax implications if you do sell your home. You may owe capital gains tax on the profit. Fortunately, many homeowners qualify for a capital gains exclusion.

If the home was your primary residence for at least two of the last five years, you may generally exclude gain up to:

• $250,000 if single, or
• $500,000 if married and filing jointly.

This means you won't owe tax on gains below that threshold. Above that amount, you could owe up to 20% capital gains tax, depending on your income, if you owned the house for more than a year. (See "Proposal in Washington to Eliminate Capital Gains Taxes on Home Sales" for information about a bill introduced in Congress that could change the rules.) Different rules apply in the case of a divorce or when a homeowner is on qualified military duty. And you may be eligible for a partial capital gains tax exclusion in certain situations when you don't meet the two-out-of-five-year rule.

What happens if you need to sell quickly for a loss — perhaps due to relocation, health issues or financial reasons? Unfortunately, a capital loss for personal-use property like a home isn't deductible on your tax return. Only losses on investment property are deductible under specific rules.

Other Routes to Consider

With the basic home sale tax rules in mind, here are four options to consider if your home isn't selling, along with the tax issues involved:

1. Rent out the property. If your home isn't generating acceptable offers, turning it into a rental property may provide steady income while you wait for the market to rebound. This approach can help offset mortgage, tax and maintenance costs — and may even offer tax benefits.

For tax purposes, once your home becomes a rental, it's treated as an investment property. That means:

• You'll report rental income on your tax return.
• You can deduct related expenses, such as mortgage interest, property taxes, insurance, repairs and depreciation.
• You may lose the ability to exclude capital gains under the $250,000/$500,000 primary residence exclusion if you eventually sell. If you rent for too long, you may forfeit that benefit. Consult with your tax advisor to determine how long you can rent without losing eligibility for this exclusion.

Important: The tax rules differ if you rent out your home for 14 days or less during the year. In that case, the rental income is tax-free. You don't have to report it on your tax return, but you can't deduct any rental-related expenses (such as cleaning or advertising) for those days.

2. Offer seller financing. In a seller-financed sale, you act as the lender and receive payments from the buyer over time instead of receiving the full purchase price upfront. In a slow market, this might attract buyers who don't qualify for traditional loans or prefer different terms.

For tax purposes, you may qualify to report the gain over time using the IRS installment sale method, spreading out the capital gains tax liability across the payment schedule. You must report the interest portion of each payment as ordinary income on your tax return.

Of course, there's potential risk. If the buyer defaults, you may face repossession issues and complex tax treatment depending on how much gain was previously recognized.

3. Make strategic improvements. If your home isn't attracting offers, the problem might not be related to the market alone — it could be the property's condition, layout or features. Investing in key updates could improve your resale value or help it sell faster.

Capital improvements made while the property is your primary residence can increase your tax basis, which reduces your taxable gain when you sell. Qualifying improvements must add value, prolong the property's useful life or adapt the home for new uses. Keep detailed records and receipts to prove the basis for capital improvements. Regular maintenance doesn't qualify as an improvement for tax purposes.

However, not all upgrades are equal. A real estate agent can identify improvements with a high rate of return on investment, and your tax pro can assess how these costs would impact your eventual capital gains calculation.

4. Engage in a rent-to-own agreement. This arrangement allows the tenant to rent the home with the option to buy it later. A portion of the rent may go toward the eventual purchase price.

For tax purposes, you'll report all rent as rental income until the sale occurs. You won't recognize a capital gain until the option is exercised and the sale is finalized. What if the tenant pays an upfront option fee? It's typically treated as advance rent (taxable income) until the sale occurs — or potentially nonrefundable income if the tenant doesn't exercise the option.

This structure may affect your ability to claim the primary residence exclusion. Timing is critical. If you rent the property for too long before the sale, you may no longer meet the two-out-of-five-year rule.

Moving Forward

Figuring out what to do if your home isn't selling is frustrating, especially if your financial plans hinge on the sale. But by understanding your options, you can make a well-informed decision that helps support your financial goals and takes advantage of potential federal tax breaks. State taxes may also apply. Consult with your tax advisor before deciding on the optimal strategy for your situation.

Proposal in Washington to Eliminate Capital Gains Taxes on Home Sales

If a new bill gains traction, there could be good news ahead for homeowners looking to sell their homes. Currently, qualified sellers can exclude up to $250,000 in capital gains from the sale of a primary residence ($500,000 for married couples filing jointly). This limit was set in 1997.

U.S. Rep. Marjorie Taylor Greene (R-GA) has introduced a bill to raise or eliminate that exclusion, calling the current threshold "an outdated, unfair burden," particularly in today's high-priced housing market. She says the change could boost the housing supply by removing a financial barrier to selling.

The "No Tax on Home Sales Act" is still in its early stages so it's unclear whether it could be enacted. But it has caught the attention of President Trump who said he's "thinking about no tax on capital gains on houses."