If you have lived in your home for a considerable amount of time and decide to sell, you may have a gain in equity if the value of your house has risen in the past few years. Unfortunately, while that extra equity is a good thing, you will have to pay taxes on the capital gains.
Tracking Capital Improvements
To determine the amount of capital gain on your home after it has been sold, you should take the sales price and deduct your adjusted cost basis. To determine your adjusted cost basis, you need to begin with the original price that you paid for your home. If you make any additional improvements such as remodeling a bedroom, replacing a roof or upgrading your furnace, you can use these costs as exclusions. It should be noted that you cannot include maintenance or repairs as improvements. These include jobs like repairing a broken toilet.
How Much To Exclude?
There are some definite benefits if you have been a longtime homeowner. The IRS allows you to take exclusions up to $250,000 if you’re single and $500,000 if you have a spouse. You must meet the following qualifications to maximize your exclusions:
– Primary residence
– Owned your home for two years or more before selling
– Lived in your home 40 percent of the time in the last five years
– No exclusions taken in last two years from home sale producing a capital gain
– $250,000 maximum exclusion if single
– $500,000 maximum exclusion if married
It must be noted that there are also different types of property that you can sell. You may have sold a rental home, which has given you a capital gain. It’s best to consult a professional who specializes in taxes so that you understand the exclusions you can take when property is not your primary residence.
Let’s say you have lived in your home for the last 20 years. In 1998, you purchased your home for $150,000. If you sell your home in 2018 for $300,000, you have a capital gain of $150,000. Let’s also say that you made $50,000 in improvements in that 20 year time frame. Here are some scenarios that show how you can take advantage of exclusions on your taxes:
First Scenario – Take no capital gains exclusion: You are not required to take exclusions. In this scenario, you made $150,000 in capital gains on your home sale. If those capital gains are taxed at a rate that’s equal to 15 percent, you will owe $22,500 to the IRS.
Second Scenario – You are single: As a single person living in that home for 20 years, you can take a maximum exclusion of $250,000. You would owe taxes on ($300,000 – $150,000 = $150,000) $150,000. However, you can deduct the $50,000 ($300,000 – $50,000 = $250,000) that you made in improvements. This would mean that you would owe taxes on ($250,000 – $150,000 = $100,000) $100,000. At a capital gains tax rate of 15 percent, you would pay $15,000 for your capital gains tax.
Obviously, if you have the ability to maximize your exclusions, you can take a large chunk out of the amount that you owe in taxes. It’s important that you keep good records of your improvements so you have proof if the IRS ever makes an inquiry.