Capital Gains Tax for Dummies
Updated: Sep 23
Will You Owe Capital Gains When you Sell your Home?
Homeowners who attend our real estate workshops want to hear about one topic above all others: capital gains tax. “I bought my home 30 years ago for $150k. If I sell, will I owe tax on the huge profit I expect to make”, I’ll typically hear from an anxious homeowner. I reply with a lawyer’s favorite response: “Well, it depends!”
What is Capital Gains Tax?
Whenever you sell an asset such as real estate, stocks, or bonds you are generally taxed on your profit. In simplest terms, profit is your sale price minus what you paid for the asset. When you sell real estate, the profit can be tens or even hundreds of thousands of dollars, which can result in a major tax bill.
Good News for Homeowners
Fortunately, the IRS recognizes the importance of home ownership and allows us to exclude up to $250,000 profit for individuals and up to $500,000 for married couples. For most of us, this exemption will wipe out any capital gains tax. However, the exemption only applies if the property has been your primary residence for at least 2 out of the last 5 years.
To illustrate, if a married couple purchased their Braintree single-family home in 1998 for $300k and sold it today for $800k, the $500k profit would result in NO capital gains tax. But what if they sold it for $900k? Will they owe on the $100k of “excess” profit? Probably not. The tax code allows you to deduct your closing costs, including your broker fee. In the example above, the 5% broker fee alone - $45k - would cut the $100k taxable amount almost in half! (Another good reason to hire an agent. See our recent article on For Sale by Owner).
The code also allows you to deduct the cost of most home improvements and major repairs, so keep your records. If you threw out the paperwork from your kitchen and bath renovation in 2003, all may not be lost. Create a detailed log of your expenditures over the years. Do it today.
Memories fade. This may prove valuable come tax time. Collectively, these deductions can significantly reduce or eliminate a capital gains hit.
If you do owe capital gains when you sell, most people will pay 15% federal tax and 5.2% state tax (did someone say Taxachusetts). The federal rate is 0% for people in the lowest income brackets and 20% in the highest, all based on current tax rates. Fortunately, the 250k/500k exemption also applies to the MA tax.
The Bottom Line
In most cases, sellers should consult their accountant or financial planner before selling, since the standard exemption doesn’t always apply. For example, selling a home out of a trust or as part of a divorce can affect how much you can exclude. Special rules also apply when selling after the death of a spouse, and for inherited property.
This article is intended for general informational purposes only and should not be construed as legal, tax or other professional advice. Prior to acting on any information in this article, you should seek legal, tax or other relevant professional counsel.