As home values continue to rise, more Americans are finding themselves owing capital gains taxes when they sell their property. However, understanding how to calculate your home’s profit can help reduce your tax bill, according to experts. Most Americans are able to take advantage of a special tax break known as the Section 121 exclusion, which allows up to $250,000 in profits for single filers and $500,000 for married couples filing jointly to be shielded from taxes. Despite this, an increasing number of home sales are surpassing these thresholds, with nearly 8% of sales exceeding the $500,000 limit in 2023, up from approximately 3% in 2019.
In order to qualify for the $250,000 or $500,000 exemptions, there are strict IRS rules that must be followed. Any profit above these limits is subject to capital gains taxes, which are levied at 0%, 15%, or 20% based on your earnings. Capital gains brackets use “taxable income,” which is calculated by subtracting the greater of the standard or itemized deductions from your adjusted gross income. It is crucial to keep track of your home’s cost basis, which includes your original purchase price plus closing costs, in order to reduce your capital gains tax liability.
One effective way to reduce capital gains taxes is to increase your home’s basis by adding often-forgotten costs and fees. These can include fees and closing costs from both the purchase and sale of the home, such as title fees, charges for utility installation, legal and recording fees, surveys, transfer taxes, title insurance, and balances owed by the seller. While these costs may individually be small, they can have a significant impact on the basis when added together. It is also important to factor in expenses related to the sale of the property, such as real estate commissions and closing costs, which can further reduce your tax liability.
While there are fees and closing costs that cannot be added to your basis, such as home insurance premiums or rent paid before the closing date, there are eligible upgrades that can be included to increase your basis. These improvements must add value to your home, prolong its useful life, or adapt it to new uses. Examples of eligible upgrades include additions, outdoor or exterior upgrades, new systems, plumbing, or built-in appliances. However, repairs or maintenance needed to keep your home in good condition, such as fixing leaks or replacing broken hardware, do not qualify. It is important to keep documentation of any improvements in case of an IRS audit.
Maintaining accurate records of home improvements is crucial for minimizing the tax owed when selling a house. By keeping track of eligible upgrades and their costs, homeowners can increase their home’s basis and reduce their capital gains tax liability. This can be achieved by adding the cost of improvements that add value to the home, prolong its useful life, or adapt it to new uses. By following these guidelines and keeping thorough documentation, homeowners can effectively reduce their tax bill when selling their property.
