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Capital Gains Tax for Dummies

Updated: Sep 23, 2021

Will You Owe Capital Gains When you Sell your Home?



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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


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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.

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6 Comments


We received this information from our realtor and friend ,Elaine Bongarzone. We are in such a dilemma- would like to sell our 4 bedrrom ,two and 1/2 baths home in a cul de sac in SCituate but we have homesteaded in Fl which gives us a big tax break, however then we will not get the exemption when we sell Scituate. I wish we had heard of you and could have visited your office when we were north this summer.

We rent our our property now, being in our 80's so want to have this off of our hands but afraid that with the septic sytem and capital gains it makes no sense

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Replying to

Thanks Tim,


Elaine's clients have been renting their house in MA for several years. Like everyone else, they hate the idea that they need to pay taxes. Knowing Elaine, I contacted her prior to responding to them. Could clarify the divorced/widowed exclusion? And I did tell her you said 'Hi'. Thanks.


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Hi, As a Realtor, I am often dealing with a widowed or divorced party with sole ownership. I believe that the exclusion for a couple still applies. All info is appreciated for clients, but can you address these circumstances.


Thanks.

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tim
tim
Sep 22, 2021
Replying to

cwalker:

Your question approaches the level of complexity where I say: “talk to your tax advisor!” :) That said, the tax code treats widow and divorce situations very differently. Generally, a widowed spouse can use his/her deceased spouse's 250k exemption provided the surviving spouse sells the property within 2 years after the date of death and the survivor doesn't re-marry during that time. This, by the way, illustrates why knowledge of capital gains is so important for homeowners selling a property they have lived in for many years or decades. On numerous occasions we've had seniors in our home seller workshops whose spouse passed away 2 or 3 years prior. Unfortunately, in that situation, their spouse's 250K exemption is…

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