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Improve Tax Outlook on Home Sale Gain Exclusion

(posted: June 27th, 2016)

home improvementOne of the biggest and best individual federal income tax breaks on the books is the home sale gain exclusion. If you qualify, you can pocket up to either a quarter or a half a million dollars of profit tax free from the sale of your home, no strings attached.

Potential Problem

The seemingly generous home sale gain exclusion might not be enough to cover the entire gain if the home has appreciated significantly since you bought it. So, you may have a king-size tax to pay when you finally sell your castle, even after taking advantage of the gain exclusion.

Strategy

Keep good records of home improvements. These expenses often can increase your tax basis for home sale purposes. Make sure you document qualified expenses from year-to-year.

Here's the Whole Story

If you've owned and used your home as your principal residence for at least two of the previous five years, you can elect to exclude from federal income tax up to $250,000 of home sale profit if you're a single filer; $500,000 for joint filers. There are no limits on the number of times you can claim the exclusion.

The taxable amount for purposes of the exclusion is the difference between the selling price and your adjusted basis in the home. For example, your basis may have been reduced to reflect rollovers from prior home sales. On the other hand, certain home improvements can increase basis to cut down the taxable gain.

Example

Say you and your spouse bought your first home for $100,000 and sold it for $400,000. Then you bought your current home for $450,000. Under the rules in effect at that time, you avoided any current tax by rolling over the home sale proceeds into your current home.

During the past few years, you've made a number of significant improvements, including an in-ground pool, deck and finished basement. The total cost of the improvements was $125,000. Now you're looking to sell the home for $750,000.

At first glance, you might think you should owe no tax on the home sale. Reason: Your $300,000 profit ($750,000 less $450,000) is sheltered by the $500,000 home sale gain exclusion for joint filers. But your actual cash basis after the sale of your first home is only $150,000 (purchase price of $450,000 less deferred gain of $300,000 from the sale of the first home). Even after you claim the home sale gain exclusion, you'd have a taxable gain of $100,000 ($750,000 minus $150,000 basis minus $500,000 home sale exclusion).

This is where detailed records can come to the rescue. As long as you can document the $125,000 of home improvements, you can increase your basis to $275,000 ($150,000 plus $125,000).

So your gain comes to $475,000 ($750,000 less $275,000), less than the $500,000 threshold. Thus, your entire gain is federal-income-tax free!

Tip: Maintain a logbook, ledger or other record of expenses you're adding to your basis. Keep the information stored in a safe place. Make backup copies of electronic files.

Tax Checklist of Home Improvements

As a general rule, a home improvement that adds to your home's value or prolongs its useful life can be added to basis. The list includes the following:

  • Finishing a basement or attic
  • New plumbing, heating or air conditioning system
  • Adding a fireplace or new room
  • Outside improvements such as a patio, deck or swimming pool
  • Installing aluminum or vinyl siding or storm windows and doors
  • New landscaping

Note the cost of repairs, such as expenses for painting, fixing gutters, plastering walls and replacing broken windows, are not added to your basis. However, if you lump in repairs with home improvements, the entire cost may be treated as a general renovation.

Tip: Schedule repairs when you're doing improvements. This gives your basis an extra nudge.

Add More to Your Basis

The following expenses may also be added to your basis, thereby reducing your potential taxable gain.

  • Attorney's fees
  • Closing costs and settlement fees
  • Title search and insurance
  • Broker commissions
  • Survey and appraisal fees
  • Recording fees for deed and mortgage

Please Contact Us with any questions.

"Health, happiness and success depend upon the fighting spirit of each person. The big thing is not what happens to us in life - but what we do about what happens to us."
-George Allen

Images: 123RF

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