Capital-Gains Tax Hits More Home Sellers

Selling a home is now so profitable that many more Americans are getting hit with an unexpected tax bill.

Roughly 8% of 2023 home sales brought windfalls over the $500,000 limit for couples to be exempt from capital-gains taxes, more than double the share in 2019, according to CoreLogic, a real-estate data firm.

More sellers are on the hook for taxes because of the huge run up in property values since the pandemic. While home prices surged, the limit on how much profit is exempt from taxes, meanwhile, isn’t indexed for inflation.

The tax hit is even more prevalent in states with high home values, such as California, where nearly a third of sales exceed the threshold. In West Virginia, less than 1% of home sales are affected.

The prospect of a big tax bill gives homeowners one more reason to remain hesitant to sell. High interest rates and elevated home prices, along with a shortage of appealing homes to move to, have led many Americans to hold off listing their homes, financial advisers said. Others don’t have a choice.

“You may need to accept the fact that you’re not able to plow every dime from the sale of your home into the purchase of your next one,” Thomas Mullooly, a financial adviser in Wall Township, N.J., told clients.

There are ways to cut down or eliminate the capital-gains tax, especially for those who can document expenses for renovations and other capital improvements.

How do capital-gains taxes on home sales work?

Taxes on capital gains apply to profits from the sale of stocks and other assets, including real estate. One of the big tax breaks for homeowners is the home-sale exclusion: Single filers get an exemption of up to $250,000 of net gains on a sale, and married couples filing jointly get up to $500,000. CoreLogic analyzed gross capital gains.

To get the home-sale exclusion, you need to have owned the home and used it as your primary residence for at least 24 months of the five years leading up to the sale. For married couples, only one spouse has to satisfy the ownership requirement, but both spouses must meet the residency test.

If the net gain on the home sale exceeds the full exemption, the excess may be taxed up to 20% if you have owned the home for more than a year. Some high earners might also face a 3.8% surtax.

The taxable gain is the difference between the selling price and the adjusted basis—what owners paid for the house, plus any renovations or other capital improvements and certain selling expenses such as real-estate agent commissions.

The exemption thresholds aren’t adjusted for inflation and haven’t changed since they were set by Congress in 1997. To provide the same tax relief as in 1997 would require an exclusion of $954,000 in today’s dollars for married couples filing jointly, said Yanling Mayer, economist at CoreLogic.

Who pays the tax?

Capital-gains taxes are most common in parts of the country with the highest home values.

Between 2017 and 2023, California alone accounted for 37% of national sales with gross capital gains beyond the $500,000 exemption limit, CoreLogic found.

Five other states represented 31% of sales nationwide that had gross capital gains above the exemption limit: New York, New Jersey, Massachusetts, Florida and Colorado.

Mullooly, the adviser in New Jersey, said many more of his clients have faced capital-gains taxes on their home sale in the past two years compared with before the pandemic.

This is especially an issue for clients selling homes in certain towns on the Jersey Shore where real-estate values have doubled or tripled, he said. Many of these clients are recent retirees who want to downsize and have owned their home for more than 25 years, said Mullooly.

To reduce the tax bill, save your receipts

Renovations and capital improvements can offset taxes and put sellers back below the threshold. Having receipts and documentation of these expenses is key.

For almost 25 years, Rosemary Kuropat and her now-wife Susan Slover kept detailed records of every home improvement they made to the Wainscott, N.Y., home they bought in 1999 for about $323,000.

The couple completely renovated the house and increased their square footage by 50% over the years. Kuropat started by collecting receipts in a big accordion folder in the basement and eventually graduated to tracking improvement costs in Excel spreadsheets.

Her organization paid off. When she sold the 2,650-square foot home last year for $2.75 million, they paid less than $50,000 in capital-gains tax, thanks in part to careful tracking.

“Good record-keeping helped us make more money off the sale,” Kuropat said.

The home improvements that can lower your cost basis

Home improvements that qualify include those that add to the value of your home or prolong its useful life such as a new roof. Fixes like plumbing repairs don’t count, said Jason Katz, a financial adviser at UBS.

Take a married couple who bought a home 40 years ago for $100,000 and recently sold it for $1.2 million.

If during those 40 years they installed a pool and a new roof that cost them $200,000, their new cost basis would be $300,000, Katz said. This would reduce the capital gains to $900,000.

After the $500,000 home-sale exclusion, the gains would be reduced to $400,000.

If their long-term capital-gains bracket is 15%, they will owe $60,000.

It could be worth it

Capital-gains taxes might cut into profits for many homeowners but the bill isn’t a reason to change their plans.

Brad Hindman, a financial adviser with Wells Fargo Advisors in Johnstown, Pa., said some of his clients who owe capital gains are selling their vacation homes in Florida this year.

Many times they aren’t using the property as much as they would like and the fixed costs such as home insurance have skyrocketed since they purchased the property.

“In those situations, they are more relieved to get rid of the property and aren’t that upset about the tax bill,” said Hindman.

Ashlea Ebeling contributed to this article.

Write to Veronica Dagher at [email protected]