As the value of homes across America continues to rise, more and more people are finding themselves liable to pay capital gains taxes when selling their properties. However, experts believe that understanding how to calculate the profit from your home sale can help you reduce the amount you owe in taxes. Although most Americans are exempt from paying taxes on the sale of their primary residence due to the Section 121 exclusion, which can shield up to $250,000 for single filers and $500,000 for married couples, a growing number of home sales now exceed these thresholds. According to a recent report from CoreLogic, nearly 8% of home sales surpassed the $500,000 limit in 2023, a significant increase from the 3% reported in 2019.
To qualify for the $250,000 or $500,000 tax exemptions, there are strict IRS rules that must be followed. Any profit beyond these limits is subject to capital gains taxes, which can be either 0%, 15%, or 20%, depending on your income level. Capital gains brackets are based on your taxable income, calculated by deducting the greater of the standard or itemized deductions from your adjusted gross income. Keeping track of your cost basis for your home – which includes the original purchase price and closing costs – is crucial. Adding often-overlooked costs and fees to your basis can help minimize your capital gains tax liability.
Various costs and fees can be added to your basis to reduce the amount of capital gains tax you owe. These include title fees, charges for utility installation, legal and recording fees, surveys, transfer taxes, title insurance, and balances owed by the seller. While these individual fees may seem insignificant, they can have a substantial impact on the overall basis when combined. It’s essential to note that some fees and closing costs, such as home insurance premiums, rent, or utilities paid before the closing date, cannot be added to your basis. Loan charges like points, mortgage insurance premiums, credit report costs, or lender-required appraisals also do not count towards increasing your basis.
One way to boost your home’s basis and minimize the tax owed on the sale is by keeping a detailed record of home improvements. Eligible upgrades must either increase the value of your home, prolong its useful life, or adapt it to new uses to qualify. Examples of improvements that can increase your basis include additions, outdoor or exterior upgrades, new systems, plumbing, or built-in appliances. However, repairs or maintenance aimed at maintaining your home’s condition, like fixing leaks or replacing broken hardware, do not qualify for increasing your basis. It’s important to have documentation for all improvements made to your home, including receipts, pictures, and permits for any home projects that may be audited by the IRS in the future.
Understanding how to calculate your home’s profit and maximize your basis can significantly reduce the amount of capital gains taxes you owe when selling your property. By carefully tracking your costs, fees, and eligible upgrades, you can take advantage of tax-saving opportunities and retain more of the profits from your home sale.