Understanding Capital Gains in Real Estate
It’s an objective opinion of value, but it’s not an exact science so appraisals may differ.
When you sell a stock, you owe taxes on your gain—the difference between what you paid for the stock and what you sold it for. The same is true with selling a home (or a second home), but there are some special considerations.
How to Calculate Gain
- In real estate, capital gains are based not on what you paid for the home, but on its adjusted cost basis. To calculate this:
- Take the purchase price of the home: This is the sale price, not the amount of money you actually contributed at closing.
- Cost of the purchase—including transfer fees, attorney fees, inspections, but not points you paid on your mortgage.
- Cost of sale—including inspections, attorney’s fee, real estate commission, and money you spent to fix up your home just prior to sale.
- Cost of improvements—including room additions, deck, etc. Note here that improvements do not include repairing or replacing something already there, such as putting on a new roof or buying a new furnace.
- Add adjustments:
- The total of this is the adjusted cost basis of your home.
- Subtract this adjusted cost basis from the amount you sell your home for. This is your capital gain.
A Special Real Estate Exemption for Capital Gains Since 1997, up to $250,000 in capital gains ($500,000 for a married couple) on the sale of a home is exempt from taxation if you meet the following criteria:
- You have lived in the home as your principal residence for two out of the last five years.
- You have not sold or exchanged another home during the two years preceding the sale.
Also note that as of 2003, you also may qualify for this exemption if you meet what the IRS calls “unforeseen circumstances,” such as job loss, divorce, or family medical emergency.
Does Moving Up Make Sense?
Answer these questions to help you decide whether moving up makes sense.
- How much equity do you have in your home? Look at your annual mortgage statement or call your lender to find out. Usually, you don’t build up much equity in the first few years of paying a mortgage, but if you’ve owned your home for a number of years, you may have significant unrealized gains.
- Has your income increased enough to cover the extra mortgage costs and the costs of moving?
- Does your neighborhood still meet your needs? For example, if you’ve had children, the quality of the schools may be more of a concern now than when you first purchased.
- Can you add on or remodel? If you have a large yard, there might be room to expand your home. If not, your options may be limited. Also, do you want to undertake the headaches of remodeling?
- How is the home market? If it’s good, you may get top dollar for your home.
- How are interest rates? A low rate not only helps you buy more home, but also makes it easier to find a buyer.
