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More Americans are paying capital gains taxes on the proceeds of selling a home as real estate values soar, but there are ways to reduce the bill, experts say.
Nearly 8% of U.S. home sales made more than $500,000 in 2023, compared with about 3% in 2019, according to an April report from real estate data firm CoreLogic.
There’s a reason the report pointed to that threshold.
This is the key to special tax breaks for homeowners who sell their primary residence for a profit. Married couples filing jointly can earn up to $500,000 on the sale without paying capital gains taxes. The threshold for single filers is $250,000.
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These capital gains exemption thresholds haven’t been indexed to inflation since 1997, said Jaime Quinones, a certified financial planner at Stockade Wealth Management in Marlboro, New Jersey.
“With the recent rise in home values, more sellers are facing a capital gains tax hit,” Quinones said.
Gains on the sale of a home above the $250,000 or $500,000 threshold are subject to capital gains taxes of 0%, 15%, or 20%, depending on income.
Capital gains taxes on home sales are more common in expensive areas. In 2023, the percentage of home sales with profits over $500,000 will reach double digits in Colorado, Massachusetts, New Jersey, New York and Washington, according to a CoreLogic report.
How to qualify for capital gains deduction
According to the IRS, the IRS has strict rules for qualifying for the $250,000 or $500,000 capital gains exemption. At that point, you must have owned the home for at least two of the past five years prior to selling it to meet the “ownership test.”
The “residence test” states that, with some exceptions, the home must be your primary residence for 24 months during the five-year period prior to sale. The 24 months do not have to be consecutive.
How to reduce capital gains tax
If you’ve lived in your home long enough to qualify for the capital gains deduction, you may have made improvements to it, says CFP Parker Trusborg, a senior financial advisor at Falls Church, Va.-based CJM Wealth Advisors. “It’s expensive,” he said. .
Those improvements can be used to raise the “baseline” or original purchase price of a home, which reduces profits, he said.
However, regular maintenance and repairs are not taken into account. For example, you can increase the foundation of your home by adding the cost of a new roof or addition. However, repairs to leaking pipes are not covered.
After you sell your home, the IRS will receive a Form 1099-S. This includes the closing date and total proceeds. However, in the event of an IRS audit, you will need documentation to prove that there have been changes to the foundation of your home.
