How to avoid a tax bomb when selling a house

With rising prices and record equity, you can expect a profit from the sale of your property. But the windfall could trigger an unexpected tax bill next April.

While home profits declined slightly, the typical single-family home seller still made $103,000 in gross profit in the first quarter of 2022, according to ATTOM, a nationwide real estate database.

Though many taxes deal with gains below the capital gains threshold, others — especially longtime homeowners — could be in for a costly surprise, experts say.

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Gains from home sales are considered capital gains, which are taxed at federal rates of 0%, 15%, or 20% in 2022 depending on taxable income.

The IRS offers homeowners a deduction that allows individual applicants to foreclose up to $250,000 of profits, and married couples who apply together can deduct up to $500,000.

But those thresholds haven’t changed since 1997, and median home selling prices have more than doubled over the past two decades, affecting many longtime homeowners.

“It’s become a big part of the conversation now,” said John Schultz, a chartered accountant and partner at Genske, Mulder & Company in Ontario, California.

While the exemption may matter to some homeowners, there are strict guidelines for qualifying. Sellers must own the home and use it as their primary residence for two of the five years prior to the sale.

“But the two years don’t have to be consecutive,” said Mary Geong, a Piedmont, Calif., resident CPA and registered agent with the firm on her behalf.

Someone who owns two homes can split time between properties, and if their cumulative time living in one place is at least two years, they can qualify.

Additionally, someone can convert a rental property into a primary residence for two years for a partial foreclosure. In this case, depreciation is based on the percentage of her time spent there, she explained.

For example, if an individual applicant owns a rental property for 10 years and lives there for 2 years, they may be eligible for 20% of the $250,000 or $50,000 exclusion.

“But you need good records,” Geong added.

increase purchase price

When homeowners exceed the allowances and owe taxes, they can reduce their profits by adding certain home improvement jobs to the original purchase price, known as the base, Schultz explained.

For example, according to the IRS, home additions, patios, landscaping, pools, new systems, and more can all qualify as improvements.

Ongoing repairs and maintenance costs that do not add value or extend the life of the home, such as: B. Painting or fixing leaks, but do not count.

Of course, homeowners need to demonstrate improvements, which can be difficult after many years. However, if someone has lost receipts, there may be other methods.

“The history of property taxes can help you go back and recalculate some of that,” Schultz pointed out, explaining how reasonable estimates can be acceptable.

Homeowners can also increase the base by adding certain closing costs, such as title, attorney, or surveyor’s fees, as well as title insurance.

Other tax issues

There is also the possibility of other tax ramifications when selling a home for a large profit.

For example, increasing adjusted gross income may affect eligibility for health insurance subsidies and potentially require someone to return award credits at tax time.

And rising retiree incomes may trigger higher future Medicare Part B and Part D premium payments.

“If you’re selling a significant asset, you should talk to some sort of advisor,” Schultz said.

A financial advisor or tax professional can project possible outcomes depending on a person’s full situation to help them make the best move. How to avoid a tax bomb when selling a house

Gary B. Graves

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