Are Expenses When Selling a House Tax Deductible?
The Internal Revenue Code offers an exclusion from capital gains tax when you sell your primary residence—you’re not taxed on a healthy portion of any gain or profit that you realize—if you meet certain rules. Your gain might be more than this exclusion, but a variety of add-ons and deductions can often keep your profits from topping the exclusion and being taxed.
The Cost Basis for Home Sale Exclusion
Everything begins with the cost basis of your home. It's subtracted from the sales price to determine how much of a gain—or in some cases a loss—you've realized.
You might have purchased your property for $250,000. You paid $7,000 in allowable closing costs. Your cost basis is $257,000 because you can include these costs in your basis.
You can also include the expense of some improvements you made to the property. Let's say you made $20,000 in structural but non-decorative improvements to your home to ready it for sale. Your basis now increases to $277,000.
You end up selling your home for $300,000. You have a capital gain of $23,000: $300,000 less $277,000.
Offsetting Basis and Gains
Adding expenses and the cost of capital improvements increases your cost basis, and a higher cost basis decreases your capital gain. If you have less of a profit, you're more likely to fall within the exclusion limit, and if your entire gain isn't excluded, you'll at least pay taxes on less profit.
For example, your gain would have been $50,000, or $300,000 less the $250,000 you paid for the property if you hadn't been able to add the cost of improvements and closing expenses to your basis.
Most costs associated with preparing the property for sale and selling it can qualify as a deduction from your gains. The "Adjusted Basis" section of IRS Publication 523 offers a complete list of possible adjustments you can make to your cost basis using these costs. Keep all your receipts so you don't overlook anything.
Most people don’t have to worry about paying capital gains tax when they sell their homes because the exclusions are significant: Married couples can exclude up to $500,000 of gain and single taxpayers can exclude up to $250,000.
You would not have to pay the tax on your $23,000 or even on $50,000. But if your gain is close to either of these thresholds, the costs of improvements and closing can make a difference.
Qualifying With Residence Test
Of course, as with most things tax-related, there are some rules. Both spouses—or a single taxpayer if he's not married—must have lived in the home for at least two of the last five years preceding the sale to qualify. This is referred to as the "residence test."
You don’t have to own the home and live in it simultaneously. You might have lived in the home as a tenant for a while before purchasing it. Nor do you have to be living there at the time you sell it—you just have to own it at that point. Your two-year residency period can occur at any time as long as it’s within that five-year period.
Qualifying With Ownership Test
You must own the property for at least two of those five years as well ending on the date of sale. This is the "ownership test" and the IRS figures that if you meet this and the residence test, the home is your primary residence. If you’re married and filing a joint return, only one of you must pass the ownership test.
If you have a co-owner—for example, you bought the property with someone else to whom you're not married—each of you can take his or her exclusion of $250,000.
There’s one last catch. You—or your spouse or co-owner—can not have claimed an exclusion for a gain from the sale of another home within the two years immediately preceding this house sale.
How Are Capital Gains Taxed?
Any gain you realize over the exclusion amount is taxed as a long-term capital gain if you owned the house for more than one year. The tax rate on long-term capital gains is either 0 percent, 15 percent, or 20 percent depending on your income. As of 2019, it works out like this.
- 0 percent on incomes up to $39,375
- 15 percent on incomes from $39,376 to $434,550
- 20 percent on incomes over $434,550
Married taxpayers filing joint returns:
- 0 percent on incomes up to $78,750
- 15 percent on incomes from $78,751 to $488,850
- 29 percent on incomes over $488,850
Head of household filers:
- 0 percent on incomes up to $52,570
- 15 percent on incomes from $52,571 to $461,700
- 20 percent on incomes over $461,700
Married taxpayers who file separate returns:
- 0 percent on incomes up to $39,375
- 15 percent on incomes from $39,376 to $244,425
- 20 percent on incomes over $244,425
Keep in mind that these are income figures, not the amount of your gain. And these income parameters changed with the Tax Cuts and Jobs Act (TCJA) in 2018. Long-term capital gains rates were tied to ordinary income tax brackets before that time.
If you owned the property for less than a year, it's a short-term capital gain and it won't qualify for the exclusion because you don't meet the residency or ownership rules. This type of gain is taxed at ordinary tax rates along with your other income. In other words, you'll effectively pay the percentage of whatever tax bracket you're in after taking all available tax credits and deductions.
Most taxpayers pay capital gains tax at the 15-percent rate, so you might want to set aside 15 percent of your taxable gain for the IRS if you don't qualify for the exclusion or 15 percent of any portion of your gain that's greater than the exclusion.
The Effect of State Taxes—Another Deduction
Check on the capital gains tax rate in your state as well. Any state taxes that you must pay on the sale of the house will not reduce your capital gain, but you can at least include these taxes as an itemized deductions on Schedule A, along with other state income taxes you paid.
The TCJA limits the state and local tax deduction to $10,000, however, beginning in 2018, and this ceiling applies cumulatively to income taxes paid to your state and local taxes as well.