Downsizing - Is the Fear of a Capital Gains Tax Keeping you from making the move?
I recently had this topic come up in a workshop I led on Downsizing. People often say: “what a nice problem to have,” but if you have owned your home for a long time and have built up significant equity, this could leave you with an awful tax bill upon its sale. That’s a common conception, which may well be a misconception—let me explain.
While I am not a professional tax advisor, I can give you some general information that may help clarify some of the finer details.
Under the current tax law, if you sell your principal residence, there are two questions for you to consider:
· Have owned your home for at least two years?
· You have lived there as your primary residence for two out of the last five years?
If both requirements are met, you will qualify to exclude $250,000 ($500,000 for a married couple) from the taxable gain upon its sale. A common question is: “if my spouse has passed away, will I still be able to exclude the full married exemption?” In most cases, the surviving spouse may get the full $500,000 exemption if they sell their house within two years of the date of their spouse's passing.
This doesn't mean you only get to exclude $500,000--there is also the Adjusted Cost Basis which will be excluded from the selling price of your home to calculate your tax liability. The Cost Basis may include the following:
· Original purchase price of your home.
· Closing and settlement costs (for both purchase & sale of your home) excluding escrow accounts that are/were used for taxes and insurance payments.
· Significant home improvements (not repairs but documented improvements such as roofing, additions, renovations, and landscaping). These items must be well documented and accounted for.
On the other hand, tax credits or home office depreciation would reduce the amount that makes up your Cost Basis.
Here is an example:
Original Purchase Price $250,000
Allowable closing costs $12,500
New roof $20,000
Kitchen remodel $50,000
Bathroom remodel $15,000
Total Cost Basis $347,500
In this example, no home office depreciation or tax credits were claimed on the consumer’s tax returns. Given the couple is married and selling their primary residence, they may be able to exclude $500,000 plus the Cost Basis of $347,500, bringing the total to $847,500 of the fair market value that will be excluded from Capital Gains Tax.
Since everyone’s tax situation is different, it’s important to visit your CPA and have them run a Cost Basis analysis for your current home and your unique financial situation.
I hope this article was helpful. The bottom-line is do not let unanswered questions or confusion stop you from simplifying and improving your quality of life.
A quote from a client of min that recently downsized:
“The freedom I feel in my new place…is like a new chance at life.” 😊
Kathleen Rose Stafford, Realtor
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