Skip to main content

Will Selling Your Home Increase Your Tax Bill?



With home prices rising 20% nationwide in the past year and in some markets, even dramatically more, many homeowners are excited about the equity in their homes.  In the past, most homeowners were not concerned about profit from the sale being taxed but some may be surprised.

The profit homeowners make on the sale of their homes have enjoyed a generous exclusion.  Since 1997, for qualified sales, single taxpayers exclude up to $250,000 of capital gain and married taxpayers filing jointly, can exclude up to $500,000 of gain.

Prior to the Taxpayer Relief Act of 1997, homeowners over the age of 55 were only allowed a once in a lifetime exclusion of $125,000.  The new rule greatly increased the amount of excluded profit to the extent that most homeowners did not think about paying tax on the profit from their principal residences.

Section 121, commonly called the Home Sale Tax Exclusion, requires that you owned and used the property as your principal residence for two out of the previous five years.  This allows for a temporary rental of the property and still be able to qualify for the exemption. It can be claimed only once every two years.

Cost basis is determined by Purchase Price plus certain closing costs at acquisition plus capital improvements made to the home during ownership.  Sales price, less selling expenses, is considered net sales price from which the cost basis is subtracted to arrive at capital gains on the sale.

If the capital gain is less than the applicable exclusion, no tax is owed.  When the gain exceeds the exclusion amount, the overage is taxed at long-term capital gains rate which could be 0%, 15% or 20% depending on the taxpayer's taxable income.

Capital improvements made to a home increase the cost basis and effectively, lower the gain in the sale.  It is important for homeowners to keep records of the money they spend during the time they own the home.

Some improvements are apparent like a swimming pool, new fence, or roof but some are not so obvious.  Replacing a faucet or a light fixture can be a capital improvement and even though the cost is small, lots of these items over the lifetime of owning the home add up.

The three rules for identifying capital improvements listed in IRS publication 523 are: 1) does it materially add value to the property? 2) does it extend the useful life of the property?  3) does it adapt a portion of the home to a new use?

While taxpayers are allowed to reconstruct a register of the improvements made during the time they owned their home, some things will undoubtedly, be overlooked.  It is much better to have a written record of all money spent on the home in a contemporaneous manner and keep receipts for items over $75.

It is better to have the record of all items available when you are ready to make the capital gain determination.  You'll save time and probably pay less taxes having the list readily available whether you do your taxes or have a professional do them.

For more information, download the Homeowners Tax Guide. 

Comments

Popular posts from this blog

Make Your Home Offer the Most Appealing

Sales in February 2023 were up 14.5% month over month and still down 22.6% year over year according to the NAR Housing Snapshot.   The median sales price dipped 0.2% to $363,000 and there are 2.6 months supply of homes on the market compared to 1.7 months a year ago. "Inventory levels are still at historic lows, and consequently, multiple offers are returning on a good number of properties." According to Lawrence Yun, Chief Economist for the National Association of REALTORS�. It is still important to have a strategy for potentially competing with other buyers on the house you want to buy.   The plan should include several available provisions and options, so that at the time of drafting the sales offer, you can consider exactly what to include based on the situation. Unless a person is paying cash, you need to be pre-approved by a trusted mortgage professional long before you start looking at homes.   Include the written pre-approval letter along with the offer

Rethinking Backup Offers

Like with any professional, there are tools and techniques available to help with particular situations.   They might be more popular at certain times and might even be put aside or forgotten at others. For real estate professionals, one of those is the backup offer.   In a situation where there are multiple offers, the seller can accept any offer for whatever reasons are important to them, leaving the makers of the other offers disappointed.   There is always some uncertainty that the buyers on a contract will close accordingly.   To hedge on that possibility, the seller may choose to make a counteroffer to one or more of the other offers to be a backup should the primary contract not close. From a buyer's perspective, the purpose of a backup offer is to be next in line to have the chance to purchase the property should the first contract fall through. The benefit is that you'll be next in line to purchase the home without having to submit another offer and possi

Getting Comfortable with the New Normal Mortgage Rates

The biggest shock to homebuyers is the soaring mortgage rates of 2022 that doubled in one year resulting in approximately 15 million mortgage ready buyers displaced from the market due to affordability issues. As of February 23, 2023, the 30-year fixed rate mortgage was at 6.5%.   While that is twice as high as it was on January 6, 2022, it is still lower than the 7.75% average rate since April 2, 1971, according to the Freddie Mac Primary Mortgage Market Survey. When rates increase at a rapid pace like this, it takes time for the public to adjust and begin to accept it as the new normal. Prior to the housing bust that led to the Great Recession, the normal for mortgage rates was in the 6% range and existing home sales were over 6.5 million for three years.   From 2007 to 2014, home sales were closer to 5 million with 2008-2011 at just above 4 million annually. From January 17, 2008 to March 5, 2020, mortgage rates averaged 4.32%.   In this 12-year period, buyers exper