Capital Gains Taxes on the Sale of your Home

This blog is primarily about helping people buy and sell homes. Earlier this year, I wrote a four-part blog on ideas for preparing your home for sale by decluttering and dressing your home for a successful sale. While that may be a lot of work, those tasks can help you save a lot of time and expense when you’re ready to sell.

This post is somewhat similar. When you sell your home, Uncle Sam, as usual, wants his cut of the action in the form of Capital Gains Taxes. Although it is not too painful for most of us,  I want you to be aware of the tax and help you understand some of the rules, so you can be prepared. Hopefully you will pay as little in taxes as possible or perhaps make a little more on the sale.

This is a complicated subject, so let me make my disclaimer here. I am a REALTOR, not a financial advisor, CPA or tax expert. The following information is deemed to be accurate, but not guaranteed. This post is not intended to provide tax advice, but rather to make the reader aware of the basic rules that may apply to their specific situation. You are encouraged to reach out to appropriate experts.

Most of the time, when we sell our homes, we sell it for more than we bought it for; we sell it for a profit or capital gain. The tax code requires us to pay taxes on those gains. Capital gains are essentially the appreciation in the value of the home. For the last 25 years or so, the average home in our area has appreciated 5.5% per year. Most homes are a great investment! As an example, let’s say I bought my home for $125,000 (Cost Basis) and sold it for $800,000. Stated in a formula:

Sale Price – (Purchase Price + Improvements) = Capital Gain (Loss)

The appreciation or gain in value is $675,000. This is income, classified as Capital Gains, for the year in which the home is sold. We will discuss adjustments and tax rates further down in the post.

The tax code allows for some immediate relief or exclusions for some of those gains, if you qualify. You can exclude $250,000 as a single filer or $500,000 if you file a joint tax return.

To qualify for the exclusion, you must meet both the “ownership test” and the “use test” as follows:

Ownership Test: You must have owned and used your home as your main residence for at least two years out of the five years prior to its sale and

Use Test: During those five years, the home must have been your primary residence for the required period.

For complete eligibility requirements, limitations, and exceptions to the two-year rule, please refer to IRS “Publication 523, Selling Your Home”, There are additional rules for military, some government personnel and installment sales.

Upon the closing of the sale, the Title company will normally file Form-1099S with the IRS. If they do, you will need to report the sale even if the sale is fully excludable. You report your home sale on your income taxes for the year in which you sold it, using the Form 1040. The home sale is reported on “Schedule D (Form 1040)” and “Form 8949” for your return. However, Capital Gains are taxed at a special rate. Based on your tax filing status, the rate you pay depends on the net capital gain as shown in the table below.

Rate	Single	Married Filing Jointly	Married Filing Separately	Head of Household
0%	$0 – $47,025	$0 – $94,050	$0 – $47,025	$0 – $63,000
15%	$47,025 – $518,900	$94,050 – $583,750	$47,025 – $291,850	$63,000 – $551,350
20%	$518,900+	$583,750+	$291,850+	$551,350+

Some special circumstances:

Surviving Spouse

1. Exclusion: If you’re a surviving spouse and you sell your home within two years of your spouse’s death, you may qualify for the full $500,000 exclusion from capital gains tax. The same exclusion rules apply.
• If you’re a surviving spouse Beyond Two Years, you can exclude up to $250,000 of capital gains from your gross income.
• However, any gain beyond that amount isn’t automatically taxable. It depends on other factors.
2. Step-Up in Basis: When a property owner dies, the cost basis of the property receives a “step-up” under federal law. Depending on the legal ownership of the property, this may mean at the time of your spouse’s death, the new cost basis is the fair market value of the property, and not the original purchase price.

Capital Improvements

The cost of home improvements that increase the value of the home, not just maintain value, may be added to the original purchase price to decrease capital gains. In general, you can’t include any costs of repairs or maintenance that are necessary to keep your home in good condition but don’t add additional value or prolong its life. Examples include painting (interior or exterior), fixing leaks, filling holes or cracks, or replacing broken hardware. However, you may include these costs if they are part of a capital improvement project.

Costs of improvements that add to the value of your home, prolong its useful life, or adapt it to new uses, may be added to the basis of your property. The following chart lists some examples of improvements.

 

Realistic Examples from Southern Frederick County:

Filer Type:	Married Filing Jointly	Married Filing Jointly	Single (Widower)	Single (Divorced)
Purchase Price:	$55,000	$254,960	$38,530	$177,000
Step-up	0	0	$333.495	0
Sale Price:	$560,000	$800,100	$600,000	$560,000
Capital Gains:	$505,000	$545,140	$266,505	$383,000
Exclusion:	500,000	$500,000	250,000	$250,000
Improvements:	$35000	$75,000	0	$65,000
Net Capital Gain:	$-30,000	$-29,860	16,505	$68,000
Capital Gains Rate:	N/A	N/A	0%	15%

*These examples are actual purchase prices; the rest of the numbers may be actual or reasonable estimates.

Of course, you will need receipts and documentation to substantiate the costs of these improvements. If you think you may need them, try reaching out to the company that performed the work to see if they can provide you with the information. Like decluttering and showcasing your home, gathering and organizing these receipts can be done long before you decide to sell, making the home sale and income tax season far less stressful.

I want to stress again: this is a highly complex tax topic, and we have only just covered the most common aspects of the law. I highly recommend that you consult a competent tax professional or refer to official IRS publications for specific guidance.  

If it would be beneficial to you to know the current market value of your home, offer a free service called a “Real Estate Review.” I can review with you the basis of the estimate and even provide a signed letter stating my opinion of the value.

I hope this has been beneficial to you. Please let me know how I can help you today.