When you sell a primary residence, the IRS allows you to exclude the first $250,000 of the gain from your capital gains taxes if you file alone, or $500,000 of the gain if you file jointly. However, you must include any excess of those amounts in your taxable capital gains for the year. So, what if you sell your home for an $800,000 profit? You’ll likely have to pay taxes on a large portion of that sale, though you’ll get a significant tax deduction in the process.
Do you have questions about downsizing for retirement or retirement planning in general? Speak with a financial advisor today.
How Capital Gains Works When Selling a House
When you sell assets, from real estate to investments to personal property, the gains are considered capital gains. The IRS calculates those gains as follows:
Sales price – Tax base = Taxable capital gain
The sales price is the amount you received for selling the property, and the tax base is the amount of capital you invested in the underlying assets. For real estate, this generally includes:
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The price paid to purchase it, including legal fees, property insurance and costs for setting up necessary services such as utilities
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Costs of improvements and upgrades to the building or property (generally any costs that improve the property or extend its useful life are considered)
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Some costs associated with selling the property, including real estate agent fees, advertising and costs associated with showing the property
However, this usually does not include property taxes, financing or interest costs, usage and occupancy costs and necessary maintenance.
For example, suppose you buy a house for $500,000. You have the following hypothetical expenses:
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$40,000 in mortgage interest
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$25,000 to renovate the kitchen
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$10,000 to install a new boiler if the old one is broken
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$6,000 to repair a weak spot in the roof
If you were to sell the house now, your cost of ownership would be $535,000, since the house cost you $500,000 and the kitchen and water heater both count as upgrades to the property ($25,000, plus $10,000). Even though the old water heater was broken, by installing a new one instead of repairing the old one, it counts as an update.
Your financing costs do not count, nor do the necessary repairs you have made to the roof. Repairs are considered costs to maintain the existing value of the property rather than upgrades to improve the value of the property.
If you later sell the house for $700,000, you will have $165,000 in potential taxable capital gain ($700,000 – $535,000 = $165,000).
If you have any questions about your retirement planning, it is best to contact a financial advisor.
What is the exclusion when selling a home?
When you sell a primary residence, the IRS allows you to take a home sale exclusion, also known as a Section 121 exclusion. Under this rule, you can exclude a certain amount of the profit from the sale of the primary residence from your taxable capital gains. For single filers, this amount is $250,000 and for joint filers, it is $500,000.
You must meet certain conditions to claim this exclusion. In particular:
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You must have owned the property for 24 of the last 60 months (this cannot be consecutive)
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You must have used the home as your primary residence for 24 of the last 60 months (not consecutive)
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You may not have claimed the home ownership exemption in the past two years
Individuals who meet these conditions can first eliminate the excluded amount from their gain from the sale of their home and then include the remainder in their taxable capital gains for the year. Individuals who do not meet these conditions must include all of their gain from the sale of the property in their taxable capital gains for the year.
For example, let’s say you sold your home and have $800,000 net after deducting the property’s tax basis. Here’s how you would break that down:
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When you are home does not qualify For the Section 121 exclusion, your taxable capital gain is $800,000.
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When you are home is eligible for the Section 121 exclusion, you have taxable capital gains of $550,000 as a single filer ($800,000 – $250,000 = $550,000) or $300,000 as a joint filer ($800,000 – $500,000 = $300,000)
The advantage of the home sale exclusion is that it is simple and offers a significant amount of relief. Most households can avoid taxes on much or all of the gain from the sale of their home under this law, and the rules are very simple. Consider consulting with a financial advisor to plan a tax strategy for your home sale and beyond.
Conclusion
When you sell your home, you can take an exemption of $250,000 (single) or $500,000 (joint) from your capital gains. After that, you must pay taxes on the remaining profit from the sale. This is a significant and simple tax deduction, but it means at least some tax for sales with a particularly high profit.
Tips for selling your home
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A financial advisor can help you create a comprehensive retirement plan, including downsizing. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can schedule a free introductory meeting with your advisors to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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For many households, their home is their most valuable asset. That may be a good thing, as you may literally be sitting on a strong retirement plan, but it also requires careful management. If you’re thinking about selling your home, consider these steps to ensure you do it carefully.
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Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid—in an account that isn’t subject to big swings like the stock market. The tradeoff is that the value of liquid assets can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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