While you’re focused on listing prices, offers, and closing dates, taxes deserve a spot on your to-do list well before you hand over the keys. The good news: there are real opportunities to reduce what you owe, but only if you plan ahead. JBS provides tax services to individuals and real estate investors navigating exactly these kinds of situations.
Key Points
- Homeowners who meet IRS ownership and use requirements may exclude up to $250,000 (or $500,000 for married couples filing jointly) in capital gains from the sale of a primary residence.
- Several costs associated with buying, improving, and selling your home can increase your cost basis, which reduces your taxable gain.
- Timing your sale, understanding depreciation recapture, and keeping good records can all make a meaningful difference in your tax outcome.
The Home Sale Exclusion
The IRS allows most homeowners to exclude a substantial portion of their profit from taxes when they sell a primary residence. Single filers can exclude up to $250,000 in capital gains; married couples filing jointly can exclude up to $500,000.
To qualify, you generally need to have owned the home and lived in it as your primary residence for at least two of the five years before the sale. Many homeowners believe that these two years must be consecutive, but that’s not the case. If you’ve used the exclusion within the past two years on another home, you won’t be eligible again right away.
There are partial exclusion options for those who don’t fully meet the requirements due to a job change, health issue, or other unforeseen circumstances. A tax professional can help you determine whether a partial exclusion applies to your situation.
What Counts As A Capital Gain?
Your capital gain is the difference between your selling price and your cost basis. If you bought your home for $300,000 and sell it for $600,000, that’s a $300,000 gain before any adjustments. For a single filer, the first $250,000 of that gain would be excluded, leaving $50,000 potentially subject to capital gains tax.
The rate you pay on that taxable gain depends on your income and how long you’ve owned the property. Homes held for more than a year qualify for long-term capital gains rates, which are generally lower than ordinary income tax rates.
How Your Cost Basis Can Work In Your Favor
Your cost basis isn’t just what you paid for the house. A number of expenses can be added to it, which effectively lowers your gain.
What Can Increase Your Cost Basis
Home improvements (not routine maintenance) can be added to your basis. Installing a new roof, adding masonry veneer or hardscaping, finishing a basement, adding a deck, or replacing HVAC systems all count. Keeping receipts and records of these projects over the years pays off when it’s time to sell.
Costs from your original purchase can also factor in: things like title insurance, legal fees, recording fees, and certain transfer taxes. On the selling side, real estate commissions and other closing costs reduce your net proceeds, which also reduces your taxable gain.
If you inherited the property, the rules are different. Inherited homes typically receive a “stepped-up” basis to the fair market value at the time of the original owner’s death, which can significantly reduce or eliminate a capital gain.
Depreciation Recapture (For Rental Property Owners)
If you’ve ever rented out your home or used a portion of it for business, depreciation recapture may apply. When you claim depreciation deductions on rental income over the years, the IRS requires you to “recapture” that depreciation when you sell.
This recaptured amount is taxed at a maximum rate of 25%, separate from regular capital gains rates. JBS provides tax services to real estate investors who want to understand exactly how this plays out before they list a property.
Timing The Sale Of Your House
If you’re close to the two-year ownership threshold, it may be worth waiting a few months to qualify for the full exclusion. Selling just under that mark could mean a much larger tax bill than necessary.
It’s also worth thinking about the tax year in which the sale closes. If you expect your income to be lower next year, and you’re in a position to push the closing, that could move you into a lower capital gains bracket.
For those selling investment properties rather than a primary home, a 1031 exchange is worth discussing with a tax advisor. This strategy allows you to defer capital gains taxes by reinvesting proceeds into another qualifying property.
Keep Good Records Throughout The Process
Documentation is everything in a home sale tax situation. Hold onto your original purchase documents, records of improvements, any depreciation schedules if the property was rented, and your closing disclosure from the sale.
Our team works with clients to review these records ahead of a sale so there are no surprises at tax time. If you’re thinking about selling in the next year or two, it’s worth sitting down with a tax professional now rather than after the transaction closes.
Note: This article is for educational purposes only and does not constitute tax advice. Tax rules, figures, and percentages are subject to change and this article may not be fully up to date; visit IRS.gov for the most current information and consult a tax professional for guidance specific to your situation.
