If you’re gearing up to move next year, you’ve got some work cut out for you.
You’ll need to:
And you’ll need to tack on a few more bullet points if you’re planning to move between cities or states.
Depending on your market, the home selling process is only a little bit easier—but it brings an additional element into the mix. Did you know you can get hit with a major tax bill when you close the sale?
It’s true! While it’s pretty rare for most homeowners, if you haven’t factored that tax bill into your new home purchase, you might end up sitting with a tax debt of tens or hundreds of thousands of dollars!
As pretty much anything dealing with IRS tax codes tends to be, there are a number of factors that might determine whether you are—or aren’t—taxed on your home’s sale value. So, let’s dive into a home seller’s guide to taxes.
If you’re taxed on your home’s sale, you’ll be interacting with the capital gains tax. Here’s what that is:
The IRS levies a capital gains tax on the difference between what you pay for an asset and what you sell it for. When you purchase an asset—things like stocks, bonds, cars, or real estate—the total you paid for it is called your basis. When you sell that asset, if the value has increased (commonly the case in real estate), you are taxed on that difference.
Fortunately, the capital gains tax doesn’t just kick in whenever you sell your home at a profit. The IRS has set some fairly high thresholds, allowing you to exclude:
For most taxpayers, these thresholds mean you probably won’t pay capital gains tax if your home’s value has risen since you purchased it.
Example 1: You and your spouse purchased your home for $200,000. Even if the value of your home has gone up to $700,000—a seriously huge gain—you still won’t pay any capital gains on it when you sell.
Example 2: You are single and your home has risen in value from $100,000 to $400,000. When you sell at a profit of $300,000, you’ll only pay capital gains tax on $50,000.
There are two types of capital gains rate: short-term and long-term.
It wouldn’t be the IRS if there weren’t some exceptions to the rule. You may have to pay capital gains tax on the entirety of the profit on your home for a number of disqualifying reasons:
Even though most homeowners won’t hit the totals required for capital gains tax to kick in, it becomes more and more depending on your home’s starting value or the length of homeownership. A couple in Los Angeles who buys a home $3 million in a fast-growing Los Angeles neighborhood could easily sell it 10 years later for $4 million. Will they really have to pay capital gains taxes on $500,000?
Remember the “cost basis,” the price you pay for an asset? In real estate, the total won’t just be what you paid for your home—it will also include improvements you’ve made on the home over time. You may have remodeled a kitchen, built an ADU, repaved a driveway, replaced the HVAC, or redone the landscaping. These improvements can be factored into the cost basis, adding to your purchase price.
So, keep those receipts! If that couple in LA put $150,000 into their $3 million home over the last decade, when they do sell it for $4 million, they’ll only pay capital gains taxes on $350,000!
We can’t recommend the best neighborhood in the area or whether a kitchen island should be on your list of “must haves,” but we can sure help you understand the taxes associated with your home sale—and maximize your deductions. Now that you understand how capital gains taxes work and how you can avoid getting hit with a tax bill, you can focus on the important things: the paint color, the pool, and everything in between.