- Capital gains are taxes paid on the difference between what you paid for a home and what you sell it for, based on its “adjusted cost basis”. There are some special considerations, but first let’s look at how to calculate your capital gain.
- Purchase price
- Total adjustments equals
- Cost of purchase including transfer fees, attorney fees and inspections.
- Cost of sale including inspections, attorney fees, real estate commission.
- Cost of improvements including room additions, deck, security system, major remodel, etc. Improvements must have a “useful life” of more than a year.
- Your adjusted cost basis
- The sum of your purchase price and the adjustments.
- Your capital gain
- Subtract the adjusted cost basis from the amount you sell for to get your capital gain.
EXEMPTION FROM CAPITAL GAINS
Based on the Taxpayer Relief Act of 1997, if you are single, you will pay no capital gains tax on the first $250,000. If you are married, the exemption increases to the first $500,000. Certain eligibility rules apply, but the main ones are:
- You have owned the home for at least 24 months.
- The property was your primary residence for 2 of the previous 5 years. The 2 years of residence do not need to be concurrent.
- There are other rules, but they get confusing. If you don’t fall into the above, give us a call and we’ll check and see if you are exempt. See IRS Publication 523 for more details.
RENTAL PROPERTIES AND CAPITAL GAINS
If you sell a rental property and do not meet the residence eligibility rule, you may have to pay capital gains and pay back (or “recapture”) some or all of the depreciation you were entitled to take on your property. “Recapturing” depreciation means you must include it as ordinary income on your tax return. In order to defer capital gains and recapturing depreciation, you may opt to complete a “1031” Exchange. See our article on 1031 Exchange here.
This article is for informational and educational purposes only, and in no way is any of the content contained herein to be construed as financial, investment, legal advice or instruction.
