How to Avoid a Tax Bomb when Selling Your Home

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With home values ​​soaring, many sellers expect a significant profit when listing their property. However, capital gains taxes can put a damper on their windfall.

Profits from home sales are considered capital gains, taxed at federal rates of 0%, 15%, or 20% in 2021, depending on income.

The IRS offers a depreciation for owners, allowing single filers to exclude up to $ 250,000 in profits, and married couples filing together can subtract up to $ 500,000.

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But those thresholds haven’t changed since 1997, and median home selling prices have more than doubled over the past two decades, affecting many long-term homeowners.

“It’s become a big part of the conversation now,” said John Schultz, CPA and partner at Genske, Mulder & Company in Ontario, California.

While the exemption may be significant for some homeowners, there are strict guidelines for qualifying. The sellers must own and use the house as their principal residence for two of the five years preceding the sale.

“But the two years don’t have to be consecutive,” said Mary Geong, a CPA based in Piedmont, Calif. And a registered agent with the firm in her name.

Someone who owns two homes can split the time between properties, and if their cumulative time living in one location is at least two years, they may be eligible.

Additionally, someone can convert a rental property to a primary residence for two years for a partial exclusion. In this case, the write-off is based on the percentage of their time spent living there, she explained.

For example, if a single filer owns a rental property for 10 years and lives there for two years, they may qualify for 20% of the $ 250,000 or $ 50,000 exclusion.

“But you need good record keeping,” Geog added.

Increase base to reduce profits

If homeowners exceed exemptions and owe taxes, they can reduce their profits by adding certain home improvements to the original purchase price, known as the base, Schultz explained.

For example, home additions, patios, landscaping, swimming pools, new systems and more can be considered as improvements, according to the IRS.

However, ongoing repair and maintenance costs that do not add value or extend the life of the home, such as painting or fixing a leak, will not count.

Of course, owners have to prove the improvements, which can be difficult after many years. However, if someone has lost receipts, there may be other methods.

“Property tax history can help you go back and recalculate some of that,” Schultz pointed out, explaining how reasonable estimates can be acceptable.

Homeowners can also increase the base by adding certain closing costs, such as title fees, legal or survey fees, and title insurance.

Other tax consequences

There is also the possibility of other tax consequences when selling a house at a large profit.

For example, the increase in adjusted gross income may affect eligibility for health insurance subsidies and may require someone to repay the premium credits at the time of taxation.

And retirees who increase their income may trigger higher future payments for Medicare Part B and Part D premiums.

“If you’re selling a big asset, you should talk to some kind of advisor,” Schultz said.

A financial advisor or tax professional can project possible outcomes based on a person’s full situation to help them choose the best decision.


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