How to understand and reduce taxes when selling your house

How to understand and reduce taxes when selling your house


Liz Weston, CFP®

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If the value of your home has increased, congratulations. If you decide to sell, be careful.

Financial adviser James Guarino says some clients do not realize that profits from home sales are potentially taxable until their proceeds are ready – and in the meantime they can spend unexpected money or invest money in another house.

“They’re not happy to find that Uncle Sam not only taxes it as a capital gain, but also gets to some extent at the state level,” says Guarino, a certified public accountant and certified financial planner in Woburn, Massachusetts.

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Longtime homeowners who took advantage of previous tax rules that allowed people to transfer profits from one house to another could face a particularly unpleasant surprise. These old rules could trigger taxes, even if you are below the current $ 250,000 exemption limits per person.

Understanding how home sales profits are calculated – and how you can legally reduce your tax bill – can save you money and stress if you plan to capitalize on the current home price boom.

How tax rules have changed

Until 1997, home sellers did not have to pay taxes on their profits if they bought another house of the same or higher value within two years. In addition, people aged 55 and over could benefit from a one-time exclusion to avoid paying home sales taxes of up to $ 125,000.

The Taxpayer Relief Act 1997 changed the rules so that instead of transferring profits to another home, homeowners could exclude profits from the sale of homes up to $ 250,000. In order for a total exclusion to apply, home sellers must own and live in the house for at least two of the five years prior to the sale. Married couples could hide up to $ 500,000.

These exclusion limits have not changed in 25 years, while domestic values ​​have almost tripled. The median sale price of homes at the time of the bill was $ 145,800, according to the Federal Reserve Bank of St. Petersburg. Louis. The median for the first three months of this year was $ 428,700. Median means half of the houses sold for less and half for more.

Having a taxable profit from the sale of a house used to be relatively rare outside of luxury real estate and high-cost cities, but this is no longer true, say financial advisers.

Why your tax base is important

Your first step in determining your profit is to identify the amount you made from the sale. This is the selling price minus any selling expenses, such as real estate commissions. Then calculate your tax base. This is generally the price you paid for the house, plus some costs for closing and upgrades. The higher the base, the lower the potentially taxable profit.

Let’s say you made $ 600,000 from a house sale. You originally bought it for $ 200,000 and you remodeled the kitchen for $ 50,000. You would subtract that $ 250,000 from $ 600,000 to get capital gains of $ 350,000.

If you are single, you can exclude $ 250,000 from your profits and pay tax on the remaining $ 100,000. (Long-term capital gains are normally taxed 15% at the federal level, although a large enough profit could get you into a higher group of 20% capital gains. State tax rates vary.) If you’re married and can rule out up to $ 500,000 in profits, you don’t owe no tax.

Your tax base may be lower than the purchase price, but if you have previously postponed the profit from the sale of the house, says CPA Mary Kay Foss of Walnut Creek, California. Let’s say you sold a house before 1997 and invested $ 175,000 in a new house – the one that cost you $ 200,000. Your home’s initial tax base would be only $ 25,000. Now, if you realize $ 600,000 from the sale, your capital gain would be $ 525,000, even with a $ 50,000 kitchen remodel.

Other factors could increase your tax base and reduce your potentially taxable profits. For example, if you owned a house with a husband who died, at least half of the foundation of the house would be “increased” or increased to its market value at the time your partner died. If you live in a state-owned state like California, both halves of the house will get that move in the tax base.

How to reduce your profits

Another way to strengthen your foundation: home improvement. To qualify, these enhancements must “add value to your home, extend its life, or adapt it to new uses,” according to IRS 523, Selling Your Home.

Room accessories, updated kitchens and a new number of plumbers; repairs or maintenance, such as painting, usually do not. Also, improvements that were later ripped or replaced cannot be counted.

Home salespeople should study Publication 523 to understand what costs can reduce their profits and keep records – such as receipts – in case they are audited, says Susan Allen, senior tax practice and ethics manager at the CPA.

“Be proactive in keeping track of records, because we all know that when you go back 10 years and look for something, it’s much harder to find,” says Allen.

This article was written by NerdWallet and originally published by The Associated Press.

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