Sponsor spotlight: Keep track of home improvements to avoid a tax surprise

One of the more popular provisions in the tax code is the $250,000 capital gain exclusion ($500,000 for a married couple) of any profit made when selling your home. As long as you follow the rules, most home sales transactions are not a taxable event.

But what if the tax law changes?

– What if you rent out your home?

– What if you have a home office?

– What if you cannot prove the cost of your home?

Your best defense to a potentially expensive tax surprise in your future is proper record retention.

The problem

The gain exclusion is so high, that many of us are no longer keeping track of the true cost of our home. This mistake can be costly. Remember, this gain exclusion still requires documentation to support the tax benefit.

The calculation

To calculate your home sale gain, take the sales price received for your home and subtract your basis. Basis is an IRS tax term that equals the original cost of your home including closing costs, adjusted by the cost of any improvements you have made in your home. You might also have a reduction in home value due to prior damage or casualty losses. As long as the home sold is owned by you as your principal residence in at least two of the last five years, you can usually take advantage of the capital gain exclusion on your tax return.

To keep the tax surprise away

Always keep documents that support calculating the true cost of your home. These documents should include:

– Closing documents from the original home purchase

– All legal documents

– Canceled checks and invoices from any home improvements

– Closing documents supporting the value when the home is sold

There are some cases when you should pay special attention to tracking your home’s value:

You have a home office. When a home office is involved, it can impact the calculation of the capital gain exclusion. This is especially true if you depreciated part of your home for business use.

You live in your home for a long time. Most homes will rise in value. The longer you stay in your home, the more likely the value of your home will rise over time. For example, a sizable gain can occur when an elderly single parent sells their home after living in it for over 40 years.

You live in a major metropolitan area. Certain areas of the country are known to have rapidly increasing property values.

You rent your home. Any time part of your home is depreciated, it can impact the calculation for available gain exclusion. Home rental also can impact the residency requirement calculation to receive the home gain tax exclusion.

You recently sold another home. The home sale gain exclusion can only be used once every two years. If you recently sold a home for a gain, keeping all documents related to your new home will be critical.

The best way to protect this tax code benefit is to keep all home-related documents that support calculating the cost of your property. Please call if you wish to discuss your situation.

— By Nancy J. Ekrem, CPA
Managing Shareholder
DME CPA Group PC
Certified Public Accountants & Business Consultants
nekrem@dmecpa.com

425-640-8660

  1. Or, we can help solve affordable housing issues by changing the law so that there is less disincentive for old folks to sell their family homes. I am so old that I can recall the days when you could sell your primary residence “capital gains tax free” if you purchased another primary home within some reasonable time period. Luxury! You could “right size”, your kids could aspire to home ownership instead of renting, and people could even move closer to their jobs. Ah, the good old days! Might need to be combined with some other policy tweaks these days, but I think it must have worked. We moved four times when I was a kid, but not once since we bought the house.

    1. Lora, you neglected to mention in your comment about the good old days that the tax free capital gain might have been about $30,000. Now the gain on the sale of a house in our region may be $500,000. Do you really expect the federal government to resist the urge to tax that gain? They did not, but they set up a fairly large amount of gain that is exempt from tax.

      1. Seems they could at least have indexed or periodically increased the exemption amount. And yes, I think perhaps the feds could ease off on this tax.

  2. If I recall correctly, to be capital gains tax free the house you purchased had to be a principal residence of the same or greater value than the one you sold or the gains taxes would kick in on every home you had ever owned. We had relatives in the 80’s who sold a home in Fountain Valley CA. and bought a new home in Portland Ore. (when he got transferred) which was much nicer and cost a lot less; and then had to pay a gains tax on every home they had ever owned. To avoid this, they would have had to buy a much larger and/or fancier home than they wanted or needed. Also to Theresa’s comment, when you factor in inflation the tax free gain would have been more like $100,000+ in significance of purchasing power than the $30,000 in the example. 1980’s dollars compared to 2024 dollars is comparing apples to oranges.

    1. Good points. For sure you would have to avoid creating any “got you” policies, and yes, when the half million exemption was adopted I suspect it would have appeared to apply only to mansions.

  3. The exemption penalizes single owners. It is $250,000 for singles. That is unfair. Single people are paying to buy/own the house, all mortgage payments, insurance, all the property taxes and maintenance, remodeling etc. alone. The exception should be per transaction (the sale of the residence) NOT per person. One property sale and one $500,000 capital gains exception no matter if single or married. It’s been at level for a long time and probably should be increased to a higher amount equal for all.

    I also remember the one time sale/exemption of the primary residence and the trade up clause.

      1. Hi Lora- Our Senator Patty Murray is one of the highest ranking members of both houses of Congress. Have you asked her to work in this section of the IRS code? What other tax should the feds increase, or what program should they cut, to make up the difference if they increase the capital gains exemption for sale of principal residence?

        1. I haven’t asked anyone to work on this, just hoping. I am thinking that any dollar amount set by any level of government in 1997 (or earlier) is worth a review from time to time. (I am aware of this example, plus at least two others.) They each may still be appropriate for a variety of possible reasons, but none would likely be serving the original intent.

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