Selling a home is a big decision. You leave a community you’ve grown to know and love, uproot yourself and your family, and head towards new horizons. It’s more than a home sale, it’s a change in lifestyle. The last thing you need is to be caught off guard by owing tax – that’s why we’ll cover various tax items that you should know before you sell.
Cost basis and adjustments
Cost basis is generally the initial purchase price of the home. After purchase, it is adjusted positively through improvements made during ownership. Your basis is important because this will ultimately affect the gain or loss realized on the sale of your home. The higher the basis, the lower the gain. And inversely, the lower the basis, the higher the gain.
Home office used in a trade or business
Home offices may entitle you to deduct a portion of home maintenance expenses, utilities, property taxes, home mortgage interest, and other related expenses as a business expense which can help save money and/or taxes while foregoing separate office space. Depreciation is also an allowed home office expense. If a home office is in use, depreciation will be calculated, your basis will be lower, and a portion of the gain may be taxed higher than the capital gains rate.
Home rented out before selling
Many people convert their homes from personal use to rental properties for various reasons. Like a home office, rental properties will have ordinary and necessary rental expenses and allowable depreciation each year. Each year your home is available for rent, depreciation will be calculated, your basis will be lower, and a portion of the gain may be taxed higher than the capital gains rate.
Home gain exclusion
U.S. Code §121 states that a home sale gain exclusion is allowed up to $250,000 for taxpayers not filing jointly, and $500,000 for those who do file jointly given certain conditions are met. To qualify for the exclusion, the taxpayer(s) must have lived in the residence being sold for 2 of the preceding 5 years.
Taxpayers purchased home in 2016 for $700,000. They lived in the house up until it was sold for $1,000,000 in 2022. During their ownership, taxpayers spent $20,000 on substantial improvements to the property. The property was never rented and there was no home office. Their resulting gain is as follows:
Selling price: $1,000,000
Initial purchase price: 700,000
Improvements to home: 20,000
Basis in house upon sale: 720,000
Realized gain on sale (1,000,000 – 720,000) = 280,000
Home gain exclusion (Married Filing Jointly): (280,000)
Recognized gain on home sale: $0.00
There may be other specific limitations and circumstances where the exclusion does not apply. Selling a home is a big decision, one that is not only a very personal one, but one with tax consequences as well. Consider reaching out to your CPA before selling, it may just save you thousands in underpayment penalties, interest, and many future headaches.