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As home prices rise, more Americans are paying capital gains taxes when they sell a property. But experts say knowing how to calculate home benefits could reduce your bill.
Most Americans don’t have to pay taxes when they sell their primary residence because of a special tax break known as the Section 121 exclusion. This protects up to $250,000 in profits for single filers and up to $500,000 for married couples filing jointly.
But profits on U.S. home sales are now increasingly exceeding those thresholds, according to an April report from real estate data firm CoreLogic. Nearly 8% of sales will exceed the $500,000 limit in 2023, up from about 3% in 2019, according to the report.
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There are strict IRS rules for receiving the $250,000 or $500,000 exemption. Gains in excess of these limits are subject to capital gains tax, which can be levied at 0%, 15%, or 20% based on your earnings.
Capital gains brackets use “taxable income.” It is calculated by subtracting the greater of your standard deduction or itemized deductions from your adjusted gross income.
Reduce capital gains by increasing “basis”
“It’s important to track the cost basis of your home,” says Thomas Scanlon, a certified financial planner with Raymond James in Manchester, Conn. This is the original purchase price plus closing costs at the time of purchase.
By adding often-forgotten costs and fees to your criteria, you can reduce your profit on the sale of your home and minimize your capital gains tax liability.
For example, you can start by adding fees and closing costs to the purchase or sale of a home, according to the IRS. These may include:
Title feesPublic facility installation feesLegal fees and recording feesInvestigationsTransfer taxesTitle insuranceBalance payable by seller
These may be small amounts individually, but when aggregated they have a large impact on your base.
Assurance reports that the average closing cost nationwide is $4,243, but fees vary widely. New York, the most expensive state, has an average of $8,039, while California is a close second at $8,028.
Scanlon, who is also a certified public accountant, added: “The cost of selling the property will also be credited.” This includes real estate commissions and closing costs.
However, according to the IRS, there are some fees and closing costs that cannot be added to the basis, such as home insurance premiums and rent and utilities paid before the closing date.
Similarly, loan fees such as points, mortgage insurance premiums, costs to obtain a credit report, or lender-required appraisals don’t count.
The “best way” to reduce capital gains tax
Experts say you can further improve your home’s fundamentals by adding the cost of targeted upgrades.
Paul Fenner, CFP and registered agent, founder and president of Tamma Capital in Commerce Township, Mich. “Maintain accurate records of renovations.”
The IRS says the improvements must “enhance the home’s value, extend its useful life, or adapt it to a new use.”
For example, you can increase your foundation by adding additions, outdoor or outdoor upgrades, new systems, plumbing, or built-in appliances.
However, the IRS says it cannot perform repairs or maintenance necessary to “keep the home in good condition,” such as fixing leaks, holes, or cracks or replacing broken hardware.
Of course, you’ll want documentation of the improvements used to strengthen the home’s foundation in case there’s an IRS audit in the future.
If you don’t have a receipt, “at least take a photo” and collect any permits you got for your housing project, says Raymond James’ Scanlon.
