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. Here, we'll tell you more about what expenses to track, and how that will affect your tax obligation.
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:
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.
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 (unless it's necessitated by a larger remodeling or improvement project), or hiring a gardener to make the lawn look good.
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. Deductible home improvements include, for example:
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 owe no capital gains tax on the sale.
Regular home repairs, however, cannot be included in your list of home improvements.
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 you're made over the years. Your real estate agent should weigh in here, providing an itemized list of work that they arranged but that you ultimately paid for (even if it came out of your profits at the end of escrow.) Tracking earlier home improvements might require going back through your records and receipts.