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Additional Considerations For Capital Gains Taxes
Homeowners should also consider the ownership test. It states that you must have lived in the residence for 2 of the last 5 years.
If nothing else is broken, the homeowner may not have to pay capital gains taxes on the sale of the house, depending on the amount of the gain. Any gain over $250,000 (single filer) is subject to capital gains taxes. The limit goes up to $500,000 for married filers.
Selling a home is a complex process. Collaborating with a tax accountant can guarantee accurate computation of your adjusted cost basis and verification of the residence ownership requirement.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It does not claim to be comprehensive, has no accuracy guarantee, and should not be the main source of information when making investment decisions.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Examples shown are hypothetical and for illustrative purposes only.
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Calculating The Adjusted Cost basis
The cost basis of a new home is the purchase price. For taxes, one needs to go a little further and calculate the adjusted cost basis. Due to related closing costs, every new home purchase will have an adjusted cost basis.
Adding and subtracting expenses to the cost basis creates the adjusted basis. Money spent on closing costs and improvements is added to the cost basis. This has the effect of increasing the cost basis and thus decreasing the capital gains tax. Here’s an example using a $400,000 home sold at $500,000:
Gain using cost basis and no adjustments:
$500,000 – $400,000 = $100,000
Gain using the adjusted cost basis with $15,000 in adjustments:
$500,000 – $425,000 = $75,000
With the adjusted cost basis, the result is a $25,000 reduction in capital gains.
Here’s how to calculate the adjusted cost basis. Add as many property-related expenses as possible:
Price paid for the property
+ related transfer/stamp fees
+ restoration of the property after damage or loss
Some expenses can reduce your cost basis, which potentially means owing more taxes:
– mortgage insurance fees or discount points (these might be reflected elsewhere when filing your taxes)
– insurance payments received due to a casualty or theft loss
The final number is the adjusted cost basis.
Renovations or improvements can be made anytime, even right after purchasing the property. Improvements are defined by the IRS as costs incurred to increase the value of a property, extend its useful life, or adapt it to new uses. These are called capital improvements.
A new room, appliances, floor, garage, deck, windows, roof, insulation, air conditioning, water heater, ductwork, security system, driveway, landscaping, or swimming pool are a few examples of capital improvements. All may qualify as improvements as they are meant to increase the homes value.
Many other items can be added to the above list. Working with an accountant can help ensure that an item qualifies. General maintenance is not considered an improvement for tax purposes. However, certain maintenance may qualify as part of a qualified improvement project.
Improvements with a life expectancy of less than a year cant be deducted from your cost basis.
Watch Out For Capital Gains when Selling Your House
Are home improvements tax deductible?
The deductible expenses have to be for improvements that last more than a year. The Internal Revenue Service defines the term like this: “Improvements add to the value of your home, prolong its useful life, or adapt it to new uses.” Minor repairs, on the other hand, are not deductible.
How much is capital gains tax on home improvements?
Capital gains taxes range from 0% to 20%, depending on the seller’s income and how long the property was owned. Assuming a 15% capital gains tax, deducting $75,000 in improvements could save this taxpayer $11,250, equal to $75,000 times 15%. Capital improvement deductions aren’t useful for every homeowner.
How do capital improvements reduce property tax?
Capital improvements can reduce this tax by increasing the cost basis for a home. The original cost basis is the purchase price of the home, including closing and other costs. Any capital improvements that are done after closing are added to this cost basis.
Are capital improvements tax deductible?
A capital improvement is an addition or change to your property that improves it or increases its value. Capital improvements differ from regular home repairs because they improve or enhance the property’s value, instead of just returning it to its original condition. You can’t deduct capital improvements from your taxes until you sell your home.