One unforeseen side effect of the COVID-19 pandemic has been soaring real estate prices. While this is bad news for buyers, it’s been fantastic news for those who have real estate to sell.
You may be feeling great pressure to sell property as soon as possible—even the home you’re living in. In fact, we’ve had clients receive cold-call offers from buyers offering to buy their home—sometimes with cash! Some of these offers seem too good to be true. But are they?
Beyond the most pressing question of…where will I live if I sell my house? The next question needs to be…what are the possible tax implications?
While we can’t tell you where to live if you sell your home, we CAN explore the tax implications of selling your primary residence.
Capital gains taxes and selling your home
If there is one thing that is certain, it is that if you make money . . . Uncle Sam is likely going to want some of it. And that is definitely true if you sell something for a profit, including real estate. A capital gain is technically the difference between what you paid for something and what you sell it for. In terms of real estate, that means that if you bought your house for $200,000 and sold it for $600,000 – your capital gain would be $400,000.
The good news is that if you are selling your primary residence, there are exclusions that can reduce or eliminate the tax burden on your capital gains.
Residency Requirement
Possibly the biggest hurdle to a capital gains exemption on the sale of your primary residence is the residency requirement. Essentially, you need to have lived in your house long enough for the IRS to consider it your primary residence. According to the IRS, that means you’ve lived in your home for 2 out of the last 5 years.
Capital gains tax exemptions for unmarried people
If you are a single person, the IRS allows for $250,000 in capital gains to be exempt from taxation.
Capital gains tax exemptions for married people
If you are a married couple and you’ve filed your taxes jointly, the capital gains tax exemption on the sale of your primary residence goes up to $500,000.
Cost Basis and what it means for your tax burden
In the simplest terms, the cost basis of your home is the amount for which you purchased it. Capital gains are determined by subtracting your cost basis from the amount you sell the property for. One way to reduce your capital gains, however, is to increase your cost basis. Essentially, increases to your cost basis can reduce your gains.
But how can you increase your cost basis? Capital improvements.
Capital Improvements
Capital improvements are upgrades, alterations, or additions that improve or add value to the home. The IRS allows you to add the costs of any capital improvement to the cost basis. For example, if you bought a house for $300,000, then over the course of 10 years, added new windows, new roof, fencing, finished basement, and a new patio that totaled $150,000, that would increase the cost basis of your home to $450,000. Which, in turn, would reduce the amount of your capital gains on the property when you sell it. The bottom line: if you make major improvements to your home – save the receipts.
What qualifies as a capital improvement?
Repairs do not qualify, as they are considered maintenance for the home. To differentiate, repairing a broken window is maintenance, replacing all of the windows is a capital improvement. For work to be considered a capital improvement, it must:
- Increase the value of the home.
- Last more than one year.
- Must still be evident (i.e. – you put in new tile in the entry when you moved in, then replaced the tile with hardwood flooring 15 years later…the tile would not count as a capital improvement, but the hardwood floor would.)
A few examples of capital improvements
- New plumbing systems
- New HVAC systems
- Finishing an unfinished section of the house (attic, basement)
- Additions to the structure
- Alterations for the elderly/infirm
- Improvements to the outdoors
- New improvements (new roof, new windows, new doors, etc.)
If you are thinking about selling your primary residence, now is certainly a popular time to do it. Exceptions and allowances in the capital gains tax on the sale of your home typically allow for a generous amount of profit before any taxes take hold. Of course, always consult with a realtor, financial planner, and/or accountant before you make any decisions.
For more information on taxes and selling real estate, reach out to our PFGI experts at 610-422-3530.