Homeowners we met recently said they wanted to sell and move a year ago, but held off because they didn’t want to incur the taxes.
They live in a part of Virginia where the lots are worth more than the homes that sit on them, a “tear down”. And developers are constantly making offers to buy their homes.
When we asked them how much they paid for it and how much they spent on improvements, they told us they bought it for $200k, put $100k into improvements, and are getting offers from developers for $875k.
Should they have been concerned about taxes?
If they have lived in it for 2 of the past 5 years (they have), they can exclude $250k per individual because they are married (the same $250k applies to single filers as well) from the sale of the home.
Note: to satisfy the 2 out of 5 years they lived there, the years do not need to be consecutive. They could have lived in the home in year 1, moved out, and moved back during year 5, and would have satisfied this rule. This exclusion generally cannot be used if another home sale exclusion was claimed within the prior two years.
So, let’s do the math:
$200k purchase price
+ $100k in capital improvements
= $300k in adjusted cost basis
$875k sale price – $300k adjusted basis = $575k in capital gains
$500k is excluded from the $575k capital gains ($250k per individual), and $75k is left. They will owe capital gains taxes on the $75k.
So, this particular couple was fearful of selling because they didn’t understand the implications, but they would more than likely have had an $11,250 tax bill on the sale of the primary residence, which is 1.9% of the $575k capital gain.
Formula to calculate adjusted cost basis.
Adjusted cost basis =
Start with the purchase price.
Add
eligible acquisition/closing costs that are capitalizable (for example: certain legal fees, title fees, recording fees, transfer taxes, some surveys and abstract fees, etc.; not prepaid interest, property taxes, or insurance).
Add
capital improvements that add value, prolong useful life, or adapt the home to new uses (e.g., additions, new roof, major kitchen/bath remodel, HVAC, room additions, driveway paving, major electrical/plumbing upgrades).
Subtract
deductible casualty/theft losses and similar reductions
We often see the tax “tail” wagging the head, but understanding the size of that tail and its true impact leads to better decisions in your retirement.
Taxes matter, but they shouldn’t be the decision-maker. When you understand the rules, the exclusions, and your true after-tax outcome, you can make housing and lifestyle decisions with confidence instead of hesitation.
The Vocare Wealth Advisors Team
Any opinions are those of Vocare Wealth Advisors, and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
This is a hypothetical story and not indicative of any specific situations or client. It is presented only as an example and not intended as investment advice. Investing involves risk and there is no assurance that any investment strategy will be successful.
