As the value of homes continues to rise, more Americans find themselves potentially owing capital gains taxes upon selling their property. Typically, most individuals do not owe taxes on the sale of their primary residence due to the Section 121 exclusion. This special tax break allows up to $250,000 in profits for single filers and up to $500,000 for married couples filing jointly. However, with the increase in home sales profits exceeding these thresholds, it is essential to understand how to calculate your home’s profit accurately to minimize your tax bill.
To qualify for the $250,000 or $500,000 exemptions, there are strict IRS rules that must be followed. Any profit exceeding these limits is subject to capital gains taxes, which can range from 0% to 20%, depending on your earnings. The calculation of capital gains brackets involves your “taxable income,” determined by subtracting the greater of the standard or itemized deductions from your adjusted gross income.
One crucial aspect of reducing your capital gains tax liability is tracking the cost basis of your home. This includes your original purchase price plus closing costs from the purchase. By adding often-overlooked costs and fees to your basis, you can minimize your tax liability significantly. These costs may include title fees, charges for utility installation, legal and recording fees, surveys, transfer taxes, title insurance, and balances owed by the seller.
In addition to adding costs to your basis, you can further increase your home’s basis by including the cost of eligible upgrades. These upgrades must add value to your home, prolong its useful life, or adapt it to new uses. Examples of eligible upgrades include additions, outdoor or exterior improvements, adding new systems, plumbing, or built-in appliances. However, it is essential to note that repairs or maintenance needed to keep your home in good condition, such as fixing leaks or replacing broken hardware, cannot be included.
To ensure that you can substantiate any improvements used to increase your home’s basis in case of a future IRS audit, it is crucial to maintain accurate records. Keep receipts for all eligible upgrades and improvements, or at the very least, take pictures of the completed work. Collect any permits pulled for home projects to demonstrate the legitimacy of the improvements made.
Understanding how to calculate your home’s profit accurately and maximize your cost basis can help reduce your capital gains tax liability when selling your property. By taking advantage of eligible exemptions, adding costs to your basis, and including the cost of eligible upgrades, you can potentially minimize the taxes owed on your home sale. Remember to keep detailed records and documentation of all expenses and improvements to ensure compliance with IRS regulations and to be prepared for any potential audits.