Hopefully the rise in market prices has put you in a position to recognize a gain on the sale of your home. At current writing (March 2022), there is still a US income tax exclusion of gains up to $250,000 for individuals, $500,000 for couples filing jointly, if you have lived in your home (as a primary residence) for at least two of the past five years. While this might be good enough for many, a careful calculation of the gain can help avoid undo tax.
The first step in calculating the gain is to identify your home’s cost basis - meaning everything that you spent to pay for, improve or prolong the life of the product (aka your home). The IRS defines a capital improvement as a home improvement that adds market value to the home, prolongs its useful life or adapts it to new uses. Minor repairs and maintenance jobs like changing door locks, repairing a leak or fixing a broken window do not qualify as capital improvements. Capital improvements to add to your cost basis include:
The price you paid for the property, including settlement costs, such as: title fees, legal fees, recording fees, survey fees, and any transfer taxes or fees you paid in connection with the purchase.
Additions: An added extra bedroom or bathroom, a deck on the back of the home, a new garage, an added porch or patio....anything that adds lasting value to your home.
Lawn and grounds improvements: Value-adding landscaping projects, driveway or walkway construction, a new fence or retaining wall, adding a swimming pool, etc. can qualify as property improvements.
Exterior improvements: New windows, roof, and siding are examples. Insulation: This includes insulation in the attic, inside walls, under floors, or around pipes and ductwork.
Interior improvements: New appliances, kitchen renovations, new flooring/carpeting, the installation of a fireplace, etc.
Plumbing: Installing/enlarging a septic system, replacing a water heater, or adding a soft water/filtering system adds value.
Systems: Installing a new heating or air conditioning system, new ductwork, wiring improvements, installing a security system, solar, geothermal, generators, batteries, and irrigation systems are improvements.
Keeping tabs on these costs throughout the lifetime of a house is wise.
Cost basis does NOT include insurance premiums, moving expenses, or any mortgage-related charges (mortgage insurance, interest, credit report fees, and appraisal costs are out) and general repairs that are essential to keep something working do not qualify. Any improvement no longer part of the home must be excluded (i.e. a deck that was later replaced by the kitchen expansion). Yard maintenance, HOA fees, and property taxes also don't count.
The next step is to determine the net proceeds from the sale of your home. Start with the purchase price and deduct direct costs of selling including: sales commissions, advertising fees and legal fees. In today’s market, most sellers make home repairs and improvements in preparation for putting their home on the market. These costs - staging, carpet cleaning, painting, landscaping and general repairs, can be considered “other selling costs”, and deducted to arrive at net proceeds.
If net proceeds exceed your cost basis, congratulations! If not, remember the amazing times you had in your home, without paying rent to a landlord.
Always verify results with your tax accountant, who is more familiar with your personal situation.