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As home values rise, more Americans owe capital gains taxes when they sell real estate. But knowing how to calculate your house gain could lower your bill, experts say.
Most Americans owe no taxes on the sale of a primary home because of a special tax exemption — known as Exception to Article 121 — which protects earnings of up to $250,000 for singles and $500,000 for married couples filing jointly.
But more gains from U.S. home sales now exceed those limits, according to an April report from real estate data firm CoreLogic. Almost 8% of sales exceeded the $500,000 mark in 2023, up from about 3% in 2019, according to the report.
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There are strict IRS rules to qualify for the $250,000 or $500,000 exemptions. Any earnings above these limits are 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 standard or itemized deductions from adjusted gross income.
Reduce capital gains by increasing “basis”
“It’s important to keep track of your home’s cost basis,” which is the original purchase price plus closing costs, according to Thomas Scanlon, a certified financial planner at Raymond James in Manchester, Connecticut.
You can reduce the profit on the sale of your home by adding often forgotten costs and supplies in your basis, which minimizes your capital gains tax liability.
For example, you can start by pressing up fees and closing costs from the purchase and sale of the residence, according to the tax office. These may include:
- Title fees
- Charges for utility installation
- Legal and record fees
- Investigations
- Transfer Taxes
- Title insurance
- Balances due from seller
These could be small amounts individually, but they have a significant effect on the basis when counted.
The average closing cost nationally it’s $4,243, according to an Assurance report, but fees vary widely. In the most expensive state, New York, the average is $8,039, with California a close second at $8,028.
“You also get credit for the costs of selling the property,” added Scanlon, who is also a CPA. This includes real estate commissions and closing costs.
However, there are some closing fees and expenses that you can’t add to your basis, such as home insurance premiums or rent or utilities paid before your closing date, according to the IRS.
Similarly, loan fees such as points, mortgage insurance premiums, the cost of writing your credit report or appraisals required by your lender will not count.
The “best way” to reduce capital gains taxes
You can further increase your home base by factoring in the cost of eligible upgrades, experts say.
“The best way to minimize the tax owed on the sale of a home is to keep an accurate record of home improvements,” said CFP and registered agent Paul Fenner, founder and president of Tamma Capital in Commerce Township, Michigan.
An improvement must “add to the value of your home, extend its useful life, or adapt it to new uses,” according to the IRS.
For example, you can increase your base with additions, exterior or outdoor upgrades, adding new systems, plumbing or built-in appliances.
However, you can’t handle repairs or maintenance needed to “keep your home in good condition,” such as fixing leaks, holes or cracks, or replacing broken hardware, according to the IRS.
Of course, you’ll need documentation of any improvements used to increase the basis of your home in the event of a future IRS audit.
If you don’t have proof, “at the very least, take pictures” and gather any permits for home projects, said Scanlon of Raymond James.