As property values continue to soar, more Americans are finding themselves in a situation where they need to pay capital gains taxes on their home sale profits. According to a recent report from real estate data firm CoreLogic, nearly 8% of U.S. home sales in 2023 yielded profits exceeding $500,000, a significant increase from the 3% in 2019. This trend has implications for homeowners looking to maximize their returns from selling their primary residence.
One key aspect highlighted in the report is the threshold for a special tax break available to homeowners who make a profit when selling their primary residence. For married couples filing jointly, the threshold is set at $500,000, while for single filers, it is $250,000. These thresholds have not been adjusted for inflation since 1997, leading to more homeowners facing capital gains tax liabilities due to the recent surge in home values.
Home sale profits exceeding the $250,000 or $500,000 thresholds are subject to capital gains taxes at rates of 0%, 15%, or 20%, depending on the seller’s income. Notably, capital gains taxes on home sales are more prevalent in high-cost areas. In 2023, several states, including Colorado, Massachusetts, New Jersey, New York, and Washington, saw double-digit percentages of home sales with profits exceeding $500,000, as per the CoreLogic report.
The Internal Revenue Service (IRS) has established strict criteria for homeowners to qualify for the $250,000 or $500,000 capital gains exemption. To meet the requirements, homeowners must pass the “ownership test,” which mandates owning the home for at least two of the past five years before the sale, and the “residence test,” which stipulates that the property must be the primary residence for at least 24 months within the same five-year period.
In cases where homeowners exceed the capital gains exemptions, there are strategies to minimize tax liabilities. For example, making improvements to the home can increase its “basis,” or original purchase price, thereby reducing the taxable profit. While routine maintenance and repairs do not qualify, significant upgrades such as a new roof or addition can be added to the basis. Proper documentation of these improvements is crucial to substantiate the adjusted basis in case of an IRS audit.
As the number of Americans facing capital gains taxes on home sale profits continues to rise, it is essential for homeowners to be aware of available strategies to reduce their tax burden. By understanding the capital gains exemption thresholds, qualifying criteria, and potential tax-saving measures such as increasing the home’s basis through improvements, individuals can make informed decisions to optimize their financial outcomes when selling a primary residence.