Understanding Capital Gains

Capital Gains When Selling Your Home

A question that always comes up when clients go to sell their home is “what will I have to pay in taxes when the house sells”?

At one time, if you sold your home, you’d have to pay taxes on any profit, called Capital Gains, which if you live here in San Francisco could be a hefty sum. 

For most folks, the only alternative was to buy a more expensive home. But if you wanted to cash out for retirement or downsize you ended up writing a big check to the IRS.

Congress realized this was a problem and passed the Taxpayer Relief Act of 1997, which included a capital gains exclusion for people selling their homes.

The Act allows you to sell your primary residence and save up to $250,000 of those sale proceeds without having to pay capital gains tax to the IRS. If you are a married couple the exclusion is $500,0000. The only requirement is you need to live in your home for at least two of the five years before you sell it.

Over time, the Act has been modified to help homeowners who needed to sell their homes, before that time period, because of changes in employment, health, marital status, or other unforeseen circumstances.

Here in the city, depending on when you purchased your home you could easily realize more than $500,000 in profit from your home sale. Depending on where you are in the city, if you bought in the 90’s or before you could easily be looking at over $1,000,000 in profit.  It also is not as simple as the sale price minus the purchase price. Your gain is actually your home's selling price, minus deductible closing costs, selling costs, and your tax basis in the property. (Your basis is the original purchase price, plus purchase expenses, plus the cost of capital improvements, minus any depreciation and minus any casualty losses or insurance payments.) 

Deductible closing costs include points or prepaid interest on your mortgage and your share of the prorated property taxes.

Examples of selling costs include real estate broker's commissions, title insurance, legal fees, advertising costs, administrative costs, escrow fees, and inspection fees.

Let’s look at an example:

You and your spouse bought a house for $350,000 back in 1995 and just sold it for $1,500,000, but you'd added $150,000 in home improvements, spent $50,000 fixing the place up for the sale, and paid the real estate brokers $75,000. That leaves $875,000 minus your capital gains exclusion of $500,000 so you would owe capital gains on $375,000. This is a very simple example.

What I always tell clients is that they should speak to their CPA or tax preparer to get the most accurate information. There are many factors that go into figuring your capital gains and you really need a professional to advise you. Too often sellers don’t think about this until the sale is complete. Remember, we as Realtors, are not tax specialists.

HOW MUCH HAS THE CAPITAL GAINS EXCLUSION HELPED?

Americans were able to set aside an estimated $86 billion in savings over the past four years, thanks to the capital gains exclusion — even with a tough job market and slow economy in many parts of the country.

The exclusion also helps home buyers. Knowing they’ll be able to keep their sale proceeds without paying a hefty tax encourages many homeowners to sell, which increases housing inventory creating more choices for buyers.