It’s often said that buying a house is one of the best investments you can make. And, just like any investment, it comes with tax issues.
With an investment like stocks or bonds, the profit you make when you sell your holdings – minus the initial investment and any expenses that comprise your tax basis – is subject to tax. If you buy and sell an investment in 12 months or less, your profit is taxed as ordinary gains, just like all your other taxable income. If you hold the investment for more than a year, you get a break and your profit is considered capital gains, which are taxed at a lower rate of 0%, 15% or 20%, depending on your other income. But some options exist for homeowners to help them reduce or, in some cases, avoid capital gains taxes entirely.
A financial advisor can help you establish a plan to manage taxes associated with real estate. Get matched with a financial advisor today.
Section 121 Exclusion
There’s an additional break when you profit from the sale of a house. If the property has been your principal residence for two of the last five years, you get a one-time exemption that allows you to exclude $250,000 of the profits from tax if you’re a single filer, or $500,000 if you’re a joint filer. To qualify, you also can’t have used this exclusion in the last two years, although there are some exceptions, as the IRS outlines here, including moving for work- or health-related reasons.
If you’re a single filer, this means only $425,000 of your profit is taxable. But that’s just the beginning.
Adjust Your Cost Basis
Besides your initial purchase price, the tax basis of your home can include some improvements and other related costs, including abstract title fees, transfer or stamp taxes, owner’s title insurance and other sales-related charges. You also can include improvements made to the home, such as adding a deck, upgrading windows, modernizing a kitchen or bathroom and others. Repairs don’t count, but items needing repair that are part of an improvement do count. If you get a tax break for an improvement, such as an energy tax credit, you need to deduct that from the total cost.
If you made $50,000 worth of improvements to the house and paid various selling costs of $5,000, you’ve now knocked the taxable gain down to $375,000. And you’re not even done yet.
A financial advisor can help you determine which costs associated with your home contribute to your basis and therefore reduce your taxable gains. Talk to a financial advisor today.
Use Other Losses
If you have capital losses in some other investment, such as stocks, you can use those losses to offset the gains on your home. However, you can offset long-term gains with long-term losses only, and short-term gains with short-term losses.
So, if you lost $10,000 on a bad stock bet, and you sold those shares after holding them for more than 12 months, your taxable gain is reduced even more, to $365,000.
Tax laws can get tricky quickly. It’s best to consult a financial advisor or other tax professional to calculate your tax liability.
Another Option
What about simply rolling all your home gains into a new home? That once was allowed but has been replaced with the Section 121 exemption. But, if you don’t mind complicating things, you could delay taxes by making the sale a like-kind exchange, which applies to real estate investments. In this case, you move out, rent the home for at least two years, sell it and use the proceeds to buy a similar property, which you’d also need to rent out for a while before converting it to your primary residence. There are other complications as well, so consult with an experienced advisor before trying this yourself.
But even without complicated property exchanges, you still can whittle down what looked like a gain of $675,000 to $365,000. If you’re in the 20% long-term capital gains bracket, your original tax bill of $135,000 has been reduced to $73,000 for a savings of $62,000.
Bottom Line
A gain on the sale of your home of more than your one-time exclusion limit is taxable as a capital gain, but can be reduced by the cost of property improvements and other capital gains losses.
Tips
- Taxes are complicated and real estate taxes can be even more complicated, especially if you’re downsizing to a retirement home. Before make a sale it pays to consult with an experienced financial advisor to find ways to keep as much of your home profits as you can.
- Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
- Selling a home is a major financial decision but a financial advisor can help you evaluate its impact on your overall financial plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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