For real estate agents, this topic might seem like a no brainer. However, your clients might not know the tax implications of their pending transaction, and this article can be used as a conversation starter with them. Feel free to use this article to engage your clients in their critical thinking so they can make the right decision.
When a homeowner makes the decision to sell their home, it can be for any number of reasons: relocation, buying a bigger home, downsizing, or because it makes financial sense to do so. As their real estate agent, you will be the first person your clients turn to when these questions come up.
Whatever the reason for selling a home, there are three tax considerations that warrant a further look.
Tax concern #1: Your realized gain
When selling any real estate, the IRS definition of realized gain takes into account a lot of things you may not have thought about. According to the IRS, the basic formula for calculating your realized gain is: Sale price – selling expenses – adjusted basis. This means you need to calculate two things: selling expenses & basis. Properly calculating these two things could mean the difference of thousands of dollars in tax liability.
Selling expenses include any seller’s closing costs, real estate commissions, and any other related selling costs. You should comb through your closing documents to make sure you’ve properly accounted for all selling expenses. Do not include city & county property tax, but do include transfer taxes, if applicable.
Basis includes the original purchase price of your house, plus fees incurred during home closing, such as title insurance, legal & recording fees, or survey fees. Basis also includes the cost of any major improvements, renovations, or system replacements. The IRS makes a clear distinction between repairs that are a normal part of keeping a home in good condition (such as repairing leaks), and an improvement (such as replacing the plumbing system).
For a more comprehensive list of what can & cannot be included in selling expenses or basis calculation, you can refer to the IRS Publication 523, ‘Selling Your Home,’ which is user-friendly and available online. Real estate agents: Even if you’re not a tax practitioner, you probably are able to help clients figure out what constitutes selling expenses, as well as the difference between repairs and major improvements.
Tax concern #2: Section 121
Under Section 121, the IRS allows a taxpayer to exclude the first $250,000 of capital gain ($500,000 for married couples filing jointly) on the sale of their primary residence if they meet certain ownership and use requirements. If you owned the home for at least 24 months of the 5 years leading up to the sale, you meet the ownership requirement. If the home was your primary residence for at least 730 days of the previous 5 years, you meet the use requirements. If you’re married filing jointly, you must each meet the use requirement, even if only one person meets the ownership requirement to qualify for the $500,000 exclusion. If you’re not married, but selling the house with someone else, you may each take the $250,000 exclusion as long as each of you meets the use requirement, and at least one of you meets the ownership requirement. Even if you do not meet the requirements for a full exclusion, the IRS allows partial exclusions if you sell the home due to work or health related moves, or due to unforeseeable events such as death, divorce, natural disaster, unemployment, or other qualifying reasons. IRS Publication 523 contains more details. Real estate agents: you should have this information at the ready in case someone asks about the tax implications, even if you aren’t prepared to give tax advice.
Tax concern #3: Long Term or Short Term Capital Gain?
If you owned the home for at least a year and a day, any gains are taxed at long-term capital gains rates, which range from 0% to 23.8%. Otherwise, your gains are taxed at short-term capital gains rates, which are the same as ordinary income rates. Long term capital gains rates calculations are based upon a taxpayer’s marginal tax bracket, but are more favorable. For example, a taxpayer in the 15% tax bracket will pay 0% on a long-term capital gain. If you’re considering the sale of your home at a profit within a year of purchase, you may want to consider whether you can sell it in a manner that qualifies the sale as a long-term gain. However, if you’re selling your principal residence for a loss, you do not qualify for any type of deductible loss. For real estate agents, this is worth discussing with your clients if you believe that timing is not on their side and they would be better off waiting. For example, they may be trying to sell in the middle of winter, when no one likes looking at houses, or you’re trying to recommend some repairs in order to get their selling price.
This article is by no means an adequate substitution for unbiased advice, based upon the unique circumstances of your personal situation. Before you make any major decisions, you should sit down with a fee-only financial planner in your area so that they can help you take into account all of the other factors that can affect your planning decision. Having a relationship with a trusted professional who can help account for life’s changes is the best way for you to put together a plan that achieves your retirement goals.
Forrest Baumhover is a fee-only financial planner and the principal of Westchase Financial Planning. To find out more about Westchase Financial Planning, go to www.westchasefinancialplanning.com.