In 2021, the average U.S. home seller made a profit of $94,092, up a whopping 71% from 2019. Great news for sellers, right? Absolutely. But selling your home at a profit, like the selling of most assets at a profit, is considered a capital gain and will be taxed according to these rates:
Capital gains tax rates for 2021
|
Long-term capital gains rate |
Taxable income |
|
Single filers |
|
|
0% |
$0 to $40,400 |
|
15% |
$40,401 to $445,850 |
|
20% |
$445,851 or more |
|
Married filing jointly |
|
|
0% |
$0 to $80,800 |
|
15% |
$80,801 to $501,600 |
|
20% |
$501,601 or more |
Source: IRS
However, the IRS does have a beneficial write-off, allowing single filers to exclude up to $250,000 in profits, and married couples filing jointly can deduct up to $500,000. Also, sellers must own and use the home as their primary residence for two of the five years preceding the sale.
So, what’s the bad news? Don’t most people sell their homes for a profit below the $250,000/$500,000 thresholds? Yes, in general. But the thresholds have not changed since 1997, while the median home sales prices have more than doubled over the same period. This means that many long-time homeowners may exceed the $250,000/$500,000 thresholds if they sell their homes in the coming years, especially as retirement and home downsizing impact Baby Boomers. In other words, selling their homes might come with an unexpected and unwelcomed tax hit.
There is a certain amount of inevitability to a potential one-time capital gains tax on the sale of your home, but there is also a strategy to potentially reduce or eliminate the tax hit: increasing basis.
If homeowners exceed the exemptions and owe taxes, they may reduce profits by adding certain home improvements to the original purchase price, known as basis. For example, home additions, patios, landscaping, swimming pools, new systems, and more may qualify as improvements, according to the IRS. However, ongoing repairs and maintenance expenses that don’t add value or prolong the home’s life, such as painting or fixing leaks, won’t count.
Of course, homeowners need to show proof of improvements, which can be difficult after many years. However, if someone loses receipts, there may be other methods. Property tax history can help you go back and recalculate some of the improvements. Homeowners may also increase basis by adding certain closing costs, such as title, legal or surveying fees, along with title insurance.
The best strategy is to plan for any tax consequences after the sale of your home. Selling a house is stressful enough, and avoiding unpleasant tax surprises should be part of your long-term financial plan.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided 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. Multnomah Group does not provide legal or tax advice.