Understanding Capital Gains in Real Estate

If you sold a home this year, this may help you to understand how capital gains in real estate works.  Just like 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 holds true when 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, follow these steps:

1. Purchase price: _______________________

The purchase price of the home is the sale price, not the amount of money you actually contributed at closing.

2. Total adjustments: _______________________

To calculate this, add the following:

• Cost of the purchase — including transfer fees, attorney fees, and inspections, but not points you paid on your mortgage.
• Cost of sale — including inspections, attorney fees, 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.

3. Your home’s adjusted cost basis: _______________________

The total of your purchase price and adjustments is the adjusted cost basis of your home.

4. Your capital gain:  _______________________

Subtract the adjusted cost basis from the amount your home sells for to get 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.

• You meet what the IRS calls “unforeseen circumstances,” such as job loss, divorce, or family medical emergency.

I am not an accountant or CPA, it is always wise to consult your tax professional for any information specific to your needs or situation but since tax time is approaching I hope you have found this article helpful in understanding capital gains in real estate.

Reprinted from REALTOR® magazine (REALTOR.org/realtormag) with permission of the NATIONAL ASSOCIATION OF REALTORS®.  Copyright 2008. All rights reserved.