Well, the time has finally arrived. After more than 22 years, we have begun the process to sell our home. Our three daughters have all established themselves in New York and Boston and a multi-bedroom house seems way too large for the two of us.
We have begun the exhausting and time-consuming task of de-cluttering 22 years of life. We followed the approach of many – which is, if you have closet space you might as well fill it. And fill it we did.
There is an important financial aspect regarding selling a home that you have lived in for many years that deals with an issue in the tax code. It is a valuable tax break available to sellers of a personal residence, whether house, condo or co-op. It allows for exclusion – meaning you pay no taxes to the Internal Revenue Service – for certain amount of capital gains on the sale.
The exclusion which currently is capped at $500,000 for married couples who file jointly and $250,000 for singles and married couples who file separate returns. As we are married and file a joint return so we will be able to exclude $500,000 in gains from the taxman.
How do you claim this exclusion? It all starts with the original cost of your home. This is known as cost basis. What can be added to the original cost basis are any home improvements as well as the costs incurred when buying or selling the home such as real estate commissions.
This is where good record-keeping comes in handy. When you improved your home by adding new windows or undertook a large addition, these amounts get added to the original cost basis. In our case, we undertook two large renovations which will be able to offset potential gains from the sale price.
If you are able to sell your home in excess of this cost basis plus the additions, normally these gains would be subject to taxes on the profit. This profit would be taxed as a long-term capital gain tax, which for high-income sellers could be as high as 23.8% federal tax, as well as additional state taxes.
Now this is where the benefit comes in for exclusion. A married couple filing jointly can exclude up to half million dollars of profit from any capital gains tax. A valuable tax break indeed.
To qualify for this tax break, the seller must have lived and owned the property for two out of last five years that ends on the day of the sale. Not consecutive years, just two of the last five years. In addition, sellers can only claim an exclusion every two years.
We have begun determining not just the original cost basis of our home, but all of the money that we added to the property in improvements over the last 22 years. It’s a good idea to create a file that documents these home improvements as they occur so the task is easier when the time comes for them to sell.
Hopefully you have sold your home for more than you paid for it. And, if like many who are selling after 15 to 30 years, the likelihood is that you will have a capital gain from the sale of your home.
How do you determine the cost basis? And what costs are allowed to be included in this calculation?
The IRS has specific guidelines and worksheets to assist you. Publication 523- Selling your Home provides insights to determine your tax implications for your filing.
The following are some of the improvements that can be included to your cost basis:
Additions: Bedroom, bathroom, deck, garage, porch, patio.
Lawn and grounds: Landscaping, driveway, walkway, fence, retaining wall, swimming pool.
Systems: Heating, central air conditioning, furnace, duct work, central humidifier, central vacuum, air or water filtration, wiring, security system, lawn sprinklers.
Exterior: Storm windows and doors, new roof, new siding, satellite dish.
Plumbing: Septic system, water heater, soft water system, filtration system.
Insulation: Attic, walls, floors, pipes and duct work.
Interior: Built-in appliances, kitchen modernization, flooring, wall-to-wall carpeting, fireplace.
It’s helpful to begin to itemize all these improvements before you decide to sell your home. These improvements that were completed over the years should be included in your cost basis before you file your tax returns.
If you would like to view what the tax collectors say on the subject, click here: IRS Guidelines.