Selling a Home? First, Examine The Tax Implications

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It's spring and flowers, trees and realtor signs are in full bloom! The good news for homeowners - it's currently a seller’s market. And that's driving up prices. Before you spring into action, be sure you understand the tax consequences of selling your home.

You've probably heard about a neighbor or friend of a friend who sold a home for more than the asking price. That's not unusual in a seller’s market. So should you take advantage of the current environment and sell now? Make sure you understand the tax consequences first! Here's some information to help with your decision.

Taxes and Exclusions

Since 1997, any gain must be recognized each time you sell your residence. But there are exceptions that allow qualifying, individual homeowners to exclude up to $250,000 of gains (joint owners can exclude up to $500,000). Therefore, if your profit is $250,000 or less ($500,000 or less for joint owners), you won’t be subject to capital gain tax.

To qualify, you must meet all the following requirements:

  • Residence. The exclusion is available only on your primary residence. If you’re selling your vacation condo, you’ll have to pay taxes on the entire gain.
  • Ownership. You need to have owned the house for at least two years. 
  • Use. You must have lived in the house as your primary residence for at least two out of the last five years.
  • Prior use of exclusion. You can only use the exclusion every two years.

If you don’t meet all the requirements listed above, you’ll owe taxes on the entire capital gain from the sale of your residence.

Calculating Gain

How do you determine that magic number? To begin, you need to know the "adjusted cost basis" of the residence.

Your starting point is the original price you paid for the home. Subtract expenses the seller paid (i.e., seller-paid points on your mortgage) from the original cost of the home. To that figure add certain expenses you paid during your closing such as recording fees, survey fees, and title abstract charges.

You are also allowed to add any improvements you made to the residence during the time you owned it - the addition of a room, paving an unpaved driveway, new roof, or major landscaping. Note: You can't add the cost of general maintenance to the cost basis of the property.

Here's an example of how to calculate a gain:

Let's assume you're a single person selling your house for $400,000. You paid $105,000 for the house in 1980 (with no expenses paid by the seller) and have lived there ever since. During that time, you added a bathroom in 1985, a swimming pool in 1990, and a new roof in 2005. The total cost for all these projects was $50,000

  • Your cost basis would be $155,000 (the original cost plus improvements).
  • Your taxable gain would be $245,000 (original cost plus improvements, minus your selling price).

As a single person, you are eligible to exclude the gain up to an amount of $250,000. Therefore, you have no capital gain tax to pay on the sale of this residence.

What if the house sold for $450,000 instead of $400,000? In that case, our seller would have a gain of $295,000. After applying the exclusion of $250,000, the net taxable gain would be $45,000. At a capital gain rate of 15 percent, the tax due on this transaction would be $6,750.

What if you sell your house for less than your adjusted cost basis? That’s a tough break. Unfortunately, you can’t claim it as a loss on your tax return.

There's Always an Exception

As with many tax provisions, there are exceptions to the ownership and use tests. Some amount of the exclusion may be available for individuals who sold their home prior to living there for two years due to a change in the place of employment, health, or unforeseen circumstances. Certain exceptions are also available for members of the uniformed services.

Summary

Prior to listing your home, calculate your adjusted cost basis to ensure you will receive the full benefit of the capital gain exclusion. You may be eligible for significant tax savings, especially if you are a long-term homeowner in a seller's market. So what are you waiting for? Go ahead and put a fresh coat of paint on the walls and new plants by the mailbox to maximize the curb appeal - and the price!

Meredith Carbrey, CFP, is a Senior Wealth Advisor with Bedel Financial Consulting Inc., a wealth management firm located in Indianapolis. For more information, visit their website at bedelfinancial.com or email Meredith.

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