Selling Your House?

Maximize Your Tax-Free Gains

 

We all know that houses have appreciated significantly in the past few years. As families contemplate navigating this tricky real estate market, we’ve had countless conversations about housing affordability and transaction structures.  

 

The housing market has changed significantly since 2019. In fact, the last few years have driven the costs of owning a house up faster than we’ve seen since the 2008 housing crisis. It now costs, on average, over 50% more to buy a house than to rent.  This strongly contrasts with the prior ten years, when buying was the more affordable option.  

 

 

 

This is a huge hill to climb for renters looking to buy a house, facing high home prices and high mortgage rates. However, for those who already own homes, many have seen a lot of appreciation and are sitting on large amounts of equity.  

 

The housing supply is currently weak because rates have risen so quickly. It is tough to stomach giving up the low rates from 2020 and 2021 if you are ready to move on to a new house. This effect has kept the supply of houses low as homeowners are hesitant to give up their sweetheart deals, but eventually, life needs tend to drive purchasing decisions more than interest rates, and we expect to see homeowners start to reconsider selling their houses as rates cool and lives change. 

 

That question has led to many discussions this year about taxes: “If I sell my house today, how much money would I owe in taxes?” The good news is that the tax code provides some nice tax breaks for houses considered to be” personal residences.” 

 

To qualify as a personal residence, the house must meet an ownership and use test. You have to own the house and have lived there for two of the past five years.  This rule becomes key when considering whether to rent or sell your house, which we will circle back to later.  

 

The tax break is fairly simple: If you meet the requirements above, you don’t have to pay tax on the first 250k/500k of gains, depending on whether you file single or married taxes. This means that if you purchased a house for 1M in 2019 and it’s worth 1.5M today and you file joint taxes, you could sell your house and pay no tax!  From here, any additional gains would be taxed when you sell the house.  For example, if the house were sold in 3 years for 1.7M, the first 500k would be tax-free, while the next 200k would be treated and taxed as a capital gain.  

 

Furthermore, this is not a one-time deal.  Assuming you buy another house and live there for 2 more years, you get another capital gain exclusion for that residence!  

 

While some people make a business out of buying a personal residence, fixing it up, and selling it for a tax-free profit, it’s important to note that selling a house generally has costs, which could exceed the tax savings of 250-500k, depending on the value of the house and the selling process. While there are some nice tax benefits to be had here, it’s important not to make this decision solely for taxes! 

 

Low rates have also led many people to consider renting their previous house instead of selling.  While rentals can generate passive income, it’s important to consider the cost of losing this special tax treatment.  Getting back to the use test, once you haven’t lived in the house for two of the last five years, the entire gain will be taxable (no personal residence exclusion anymore).  For a couple in the highest capital gains bracket with over 500k of gains on their house, this could cost over 100k of taxes that could otherwise be avoided! Make sure to consider this cost when running the math on renting out what used to be a personal residence, and know that the 3rd year after moving out is the last year to make the decision. Although, you could always move back in for another year or two to requalify! 

 

So, what are some smart things that you can do along the way to save taxes when you do ultimately sell your house?

 

Here’s a quick list:

 

• Keep Accurate Records
  • Track home improvement expenses to add to the home’s cost basis, potentially reducing the amount of capital gains subject to tax.
• Deduct Selling Expenses
  • Certain expenses, such as agent commissions and legal fees, can be subtracted from the selling price to further reduce the capital gains.
• Utilize Special Circumstances
  • Explore special circumstances, such as job changes, health-related reasons, or unforeseen events, which may permit a partial exclusion even without meeting the standard ownership and use requirements. 
• Seek Professional Guidance
  • We work with clients and their tax professionals to understand the implications of one path or the other so that you can go in with eyes wide open.  It’s important to consult with a professional regarding significant transactions like these.

 

We’ve also included a checklist addressing this and other house-selling issues.

If you have further questions, we are happy to help! Please reach out to set a time to talk, and we would be happy to help think through the best action plan.

 

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Advisory services offered through National Wealth Management Group, LLC, a Registered Investment Adviser. This information is intended for educational purposes and is not intended as a recommendation to buy or sell securities. Investing involves risk. Before investing, you should consult with a financial advisor to determine how a specific investment strategy fits your personal goals and objectives.