Did you make a profit selling your home? Here’s how to avoid a tax bomb

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If you recently made a profit selling your home, this filing season may have a costly surprise in store for you: capital gains taxes on your windfall.

In 2021, the average American home seller made a profit of $94,092, up 71% from $55,000 two years ago, according to ATTOM, a national real estate database.

While many sellers’ profits fall below capital gains thresholds for primary residences, others may be hit by an unexpected bill, especially long-time homeowners, experts say.

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Profits from home sales are considered capital gains, levied at federal rates of 0%, 15%, or 20% in 2021, depending on taxable income.

The IRS is offering a homeowner write-off, allowing single filers to exclude up to $250,000 in profits and married couples filing together can deduct up to $500,000.

But those thresholds haven’t changed since 1997, and median home sales prices have more than doubled in the past two decades, hurting many long-term homeowners.

“It’s become a big part of the conversation now,” said John Schultz, CPA and partner at Genske, Mulder & Company in Ontario, Calif.

Although the exemption may be important for some owners, there are strict guidelines for qualifying. Sellers must own and use the home as their principal residence for two of the five years prior to the sale.

“But the two years don’t have to be consecutive,” said Mary Geong, CPA based in Piedmont, Calif., and registered agent at the firm on her behalf.

Someone who owns two houses can split their time between the properties, and if their cumulative time living in one location equals at least two years, they may qualify.

Additionally, someone can convert a rental property into a principal residence for two years for a partial exclusion. In this case, the write-off is based on the percentage of time spent living there, she explained.

For example, if a single filer owns a rental property for 10 years and lives there for two years, they may qualify for 20% of the $250,000 or $50,000 exclusion.

“But you need good record keeping,” Geong added.

Growing basis

If homeowners exceed exemptions and owe taxes, they can reduce their profits by adding certain home improvements to the original purchase price, known as the base, Schultz explained.

For example, home additions, patios, landscaping, pools, new systems and more can be considered improvements, according to the IRS.

However, ongoing repair and maintenance expenses that do not add value or extend the life of the home, such as painting or fixing leaks, will not count.

Of course, owners must show proof of improvements, which can be difficult after many years. However, if someone has lost receipts, there may be other methods.

“Property tax history can help you go back and recalculate some of that,” Schultz pointed out, explaining how acceptable reasonable estimates can be.

Homeowners can also increase the base by adding certain closing costs, such as title, legal or survey fees, and title insurance.

Sneaky Tax Consequences

There is also the possibility of other tax consequences when selling a home at a significant profit.

For example, increased adjusted gross income may affect eligibility for health insurance subsidies and may require someone to repay premium credits at tax time.

And rising retiree incomes may trigger higher future payments for Medicare Part B and Part D premiums.

“If you’re selling a large asset, you should talk to some type of advisor,” Schultz said.

A financial advisor or tax professional can project possible outcomes based on a person’s complete situation to help them choose the best decision.

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