The markets reached new highs again last week, as prices fell for the first time since May 2020. The Consumer Price Index for June came in below expectations at 3%, with a drop of 0.10%. This increases the chance of an interest rate cut as soon as September.
We’ve had a number of questions lately about how the gains on the sale of your primary residence are taxed. There’s a lot of misinformation out there, most based on an old law that changed under the Clinton administration. Previously, you had to roll the gains of the sale into a new home, with a once-in-a-lifetime opportunity to cash out and take the gains tax-free.
The Taxpayer Relief Act of 1997 changed all that. If you have lived in your primary residence for two of the last five years, you are usually able to exclude $250,000 in gain from your taxes. If you are married, that increases to $500,000 of gain.
The gain has nothing to do with your mortgage, if you’ve refinanced, or how much equity you have in the house. To calculate gain, you first calculate two numbers: your cost basis and your net proceeds. Cost basis is what you paid for the home, regardless of mortgage amounts. You then add the cost of any capital improvements. These are long-term investments in your home, such as new windows, a new roof or HVAC, or a major renovation. It does not include ongoing maintenance or repairs.
Your net proceeds are the selling price less any realtor commissions and closing costs, such as transfer taxes. The difference between the two numbers is your gain.
Let’s say you purchased your home 15 years ago for $350,000 and have lived there the entire time. Over that time, you did a major kitchen remodel and replaced the HVAC, for a total of $50,000. Your cost basis is $400,000: the $350,000 you paid for the home plus the additional $50,000 you invested in it. You sell the house today for $800,000, less closing costs of $56,000, for a net of $744,000. Your gain is $344,000, the $744,000 you received from the sale less your cost basis of $400,000. If you’re single, you receive $250,000 of that tax-free. The remaining $94,000 would be subject to long-term capital gains tax. If you’re married, you would pay no taxes on the sale, as the gain is under the $500,000 exclusion.
There are some exceptions to all of this. If the home was rented while you owned it, you may be subject to depreciation recapture. If it was part of a 1031 exchange, you are not entitled to the gains exclusion. And this being US tax law, there are exceptions to the exceptions, specifically for military service members, and civilian employees of the intelligence community or foreign service.
Most families will fall under the $500,000 gain exclusion, but be sure to check with a tax professional for advice for your specific situation.
Your action item is to locate and scan in receipts for all the work you’ve done on your house. When you sell it, you may need to document that work to justify your cost basis to the IRS.
Be sure to check out our website at covingtonalsina.com, or our Facebook page, for more information and to register for our upcoming educational events.
CovingtonAlsina is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.