When Home Sellers Can Reduce Capital Gains Tax Using Expenses of Sale
If your profits on your home sale are likely to be high, start cataloging your selling expenses so as to lower your capital gains tax obligation.
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Selling a house will hopefully bring in a lot of money -- but first, it will cost money, for things like spiffing the house up and paying the people who will help you sell it.
Fortunately, many of these expenses can be used to reduce the net amount you are deemed to receive from the sale for tax purposes (the “amount realized” from the sale, in tax parlance). This will in turn reduce your net profit from the sale, if any (also called “taxable gain”).
Most people who sell their personal residences qualify for a home sale tax exclusion of $250,000 for single homeowners and $500,000 for marrieds filing jointly. This means they need not pay any tax on that amount of profit from the sale. But if their profit exceeds the applicable exclusion amount, they must pay tax on the overage. If you don't qualify for the home sale tax exclusion at all, you'll have to pay such taxes on your entire gain.
Thus, keeping track of these expense can save you substantial amounts.
Types of Selling Expenses That Can Be Deducted From Your Home Sale Profit
You are allowed to deduct from the sales price almost any type of selling expenses, provided that they don’t physically affect the property. Such expenses may include:
- appraisal fees
- attorney fees
- closing fees
- document preparation fees
- escrow fees
- mortgage satisfaction fees
- notary fees
- points paid by seller to obtain financing for buyer
- real estate broker's commission
- recording fees (if paid by the seller)
- costs of removing title clouds
- settlement fees
- title search fees, and
- transfer or stamp taxes charged by city, county, or state governments.
Most of these costs will be listed in the closing statement prepared by the escrow, bank or other financial institution, (or attorney, in some states) when you sell your house.
Example: Phil and Helen, a married couple who who qualify for the $500,000 home sale tax exclusion, sell their home for $800,000. They pay a 6% sales commission to their real estate broker ($48,000) and another $22,000 for attorney fees, closing costs, escrow, and closing fees. They subtract these sales expenses from the sales price to determine the amount they realized from the sale. $800,000 - $80,000 = $720,000. Their home’s tax basis (original cost plus improvements) is $200,000. They subtract this from the amount realized to determine their gain from the sale. Thus, their gain is $520,000. This is $20,000 more than the applicable $500,000 home sale tax exclusion. Thus, the couple must pay capital gains tax on $20,000 of their profit. Had they not qualified for the $500,000 exclusion, they would have had to pay tax on their entire profit.
Types of Selling Expenses That Can't Be Deducted From Home Sale Profit
Expenses you incur that physically affect the home are not deductible from the sales proceeds, even if they help make your home more saleable. For example, you can’t deduct the cost of cleaning the carpets in your home, repainting, or hiring a gardener to make the lawn look good.
Deducting Home Improvements From Home Sale Profit
If you make substantial physical improvements to your home -- even if you did them years before you started actively preparing your home for sale -- you can add the cost to its tax basis. This will reduce the amount of any taxable profit from the sale.
For tax purposes, a home improvement is any expense that materially adds to the value of your home, significantly prolongs its useful life, or adapts it to new uses. Home improvements include:
- adding a new bedroom, bathroom, or garage
- installing new insulation, pipes, or duct work
- replacing walls and floors
- installing a new or upgraded heating and air conditioning system
- installing extensive new landscaping, such as new lawns
- installing new fences, retaining walls, porches, patios, or decks
- replacing driveways and walkways
- installing a new roof, windows, or doors
- installing new wall-to-wall carpeting, and
- installing new built-in appliances.
Example: Assume that prior to selling their home, Phil and Helen from the example above spent $25,000 to extensively remodel their kitchen. They add this amount to their home’s tax basis. Its basis is now $225,000, instead of $200,000. They subtract $225,000 from the $720,000 realized from the home’s sale to determine their net profit -- $495,000. This is less than the applicable $500,000 home sale tax exclusion for married couples, so they own no capital gains tax on the sale.
Regular home repairs, however, cannot be included in your list of home improvements.
Tracking Your Costs and Expenses
Be sure to keep a file containing all records and receipts of amounts that you spent on preparing your home for sale, as well as any home improvements.